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LECTURES 



ON THE 



Theory of Economics 



BY 



Frederick Charles Hicks 

sInton professor of economics and civics 
university of cincinnati 



Cincinnati 

The University of Cincinnati Press 

leoi 




THE LIBRARY OF 

CONGRESS, 
Two CoHiEs Received 

OCT. 17 1901 

COPVRIQHT ENTHY 

CUa^. -2.1, t^e>i 
CLASS CU XXo. No. 

/S3oo 
COPY a. 



Copyright, 1901, 
By FREDERICK CHARI^ES HICKS 



Cincinnati 

Roessler Brothers, Printet 

114-116 W. Sixth St. 



"Co 
tbe me mors of mg Brotbec 

©dbert Menri5 Micfts 



CONTENTS 



PART I PROLEGOMENA 



1 Economics 

PAGE 

Definition ........ 8 

Economic Activity 4 

Purpose of Economic Science .... 5 

Theory and Practice 7 

Economics and Selfishness 11 

Social Sciences 13 

History and Statistics 14 

Scientific Character of Economics ... 16 



2 FuNDAMENTAiv Concepts 

9. Economic Want .... 

10. Definition of Wealth 

11. Conditions Essential to Wealth . 

12. Physical Properties . 

13. Appropriability .... 

14. Money and Wealth . 

15. Definition of Value 

16. Power-in-Exchange . 

17. Scarcity 

18. Definition of Price . 

19. The Process of Measuring . 

20. Measuring Value 

21. Two-fold Result of Measurements of Value 



19 
20 
21 
23 
23 
24 
26 
26 
27 
29 
30 
32 
35 



vin CONTENTS 

8 The Law of Vai,ue 

PAGE 

22. Basis of Value 36 

23. Conditions Determining Value .... 37 

24. Variations in Value ...... 41 

25. The Law of Value 42 

26. Variations in Price 44 

27. Standard Measure of Value .... 47 

28. Test of Variations of Value .... 51 

4 The Economic Process 

29. Definition of the Process 53 

30. Social and Individual Character of Activity . 54 

31. Normal Economic Activity 66 

32. Nature of Competition and Monopolization . 57 

33. Persistence of and Limitations to Competition 

and Monopolization ..... 60 

34. Conditions of Economic Progress ... 64 
36. Services Rendered by Competition and Monopo- 
lization 65 

86. Steps in the Economic Process ... 68 



PART II PRODUCTION 



1 Production 

37. The Production of Wealth 73 

88. Productive and Unproductive Expenditures of 

Energy 76 

39. Laws of Diminishing and of Increasing Returns 77 

40. Conditions of Efficiency in the Production of 

Supply 81 

41. Conditions of Efficiency in the Production of 

Demand 82 



CONTENTS 

2 The Factors of Production 

42. Situation 

43. Efficiency of Situation .... 

44. Material, Capital 

45. Efficiency of Capital .... 

46. I^abor ........ 

47. Efficiency of L^abor 

48. Enterprise 

49. Efficiency of Enterprise . 

50. Cooperation of all the Factors Necessary 

the Production of Wealth 



to 



87 
89 
91 
94 
95 
98 
99 

101 



3 The Economic Organization 

51. The Economic Organization .... 105 

52. Division of Function 107 

53. Unification of Design 110 

54. Development of Organization .... 112 

55. New Industries Made Possible .... 114 

56. Higher Grade of Productive Agencies Developed 115 

57. Existing Agencies More Economicall}^ Utilized 116 

58. Danger of Excessive Dependence . , . 120 

59. Possibility of Overproduction .... 122 

4 The Incentive to Activity 

60. The Incentive to Activity and Production . 125 

61. Individual Character 126 

62. Rights 127 

63. Private Property Rights 128 

64. Limitations to Private Property Rights . .133 

65. Right to Contract 136 

66. Limited Liability 140 

5 The Devei/Opment oe Demand 

67. Population 144 

68. Development of Wants 145 



X CONTENTS 

PAGE 

69. Persistence of Wants 149 

70. Expansibility of Wants 151 

71. Healthfulness of Wants ..... 154 

72. Order of Development of Wants . . . 156 

73. Knowledge of the Existence and Character of 

Commodities 156 

74. Prospect of Siiccess in the Effort to Secure 

Commodities ... ... 159 



PART 111 DISTRIBUTION 



1 Distribution 

75. The Distribution of Wealth . . . .165 

76. Expansibilit}' and Exclusiveness of Wants . 166 

77. The System of Distribution Subject to Change 168 

2 The Basis of Distribution 

78. Fundamental Characteristic of a System of 

Distribution 172 

79. Test of the Sufficiency of a Basis of Distribu- 

tion 174 

80. The Basis of Equality 174 

81. The Basis of Need 176 

82. The Basis of Contribution to Production . 181 

83. The Basis of Value of Services . . . .184 

3 Exchange 

84. Relation of Exchange to the Economic Process 185 

85. Conditions Essential to an Exchange . . 187 

86. Medium of Exchange and Credit ... 188 

87. Agreement as to the Rate of Exchange . .191 

88. Relation of the Terms of an Exchange to Dis- 

tribution 192 

89. Extension of Sales 194 



CONTENTS XI 

PAGE 

90. Increase of Price 197 

91. Law of Price 201 

92. Relation of Competition and Monopolization to ' 

Each Other 201 

93. Effect of Movements in Price upon Distribution 204 

94. Introduction of a Medium of Exchange and 

of a Standard Measure of Value . . 206 

4 The Sharks in Distribution 

95. The Shares in Distribution . . . .209 

96. The Fund to be Distributed .... 210 

97. Principles Determining the Shares . . . 212 

98. Minimum and Maximum Limits to the Shares 216 

99. Effect of Variations in the Shares Upon Each 

Other 217 

100. Relation of Competition and Monopolization 

to Each Other 219 

101. Effect of the Introduction of a Medium of Ex- 

change and of a Standard Measure of Value 220 

5 Rent 

102. Summary of the Principles of Distribution as 

Applied to Rent . . . . _ . .224 

103. Nature of Rent 225 

104. Monopolization and Competition in Relation to 

Rent 229 

105. Minimum Limit to Rent 231 

106. The Ricardian Doctrine of Rent . . . . 232 

107. Criticism of the Ricardian Doctrine of Rent . 235 

108. Rent and the Prices of General Commodities . 238 

109. The Unearned Increment .... 241 

6 Interest 

110. Summary of the Principles of Distribution as 

Applied to Interest 242 



xii CONTENTS 

PAGE 

111. Nature of Interest 243 

112. Variations in Interest Returns .... 246 

113. Minimum and Maximum Limits to Interest . 249 

114. Money and Interest 251 

7 Profits 

115. Summary of the Principles of Distribution as 

Applied to Profits ..... 267 

116. Some Features of the Working of the Principles 

of Distribution in the Case of Profits . . 258 

117. The Rent Theory of Profits .... 262 

118. Criticism of the Rent Theory of Profits . . 264 

119. Profits and the Prices of General Commodities 266 

120. Excessive Profits 268 

8 Wages 

121. Summary of the Principles of Distribution as 

Applied to Wages ..... 271 

122. Commercial and Economic Wages . . . 272 

123. Susceptibility of Labor to Competition . . 274 

124. The Residual Claimant Theory of Wages . 276 

125. Criticism of the Residual Claimant Theory of 

Wages 278 

126. Relation of Wages to Past and Future Product . 281 

127. Relation Between the Variations in the Wages of 

Different Laborers 283 

128. Wages and Variations in General Prices . . 284 



PART I 



PROLEGOMENA 



ECONOMICS 



1. The science of economics grew out of the at- 
tempt to formulate precepts for the guidance of the 
State in its relation to business, a fact reflected in 
the name "political economy," which has so long 
been used to designate the subject. It was found 
that the formulation of such precepts requires a 
knowledge of the wider field of general business 
activity. Accordingly, the domain of the economist 
came to be considered co-extensive with the entire 
range of business operations; and, since in business 
men seek wealth, the science was defined as "that 

Keynes, The Scope and Method of Political Economy ; 
Caimes, The Character and Logical Method of Political 
Economy, 2d. ed., lectuies i-vi. ; Cos?a, An Introduction 
to the Study of Political Economy, trans, by Louis Dyer, 
Theoretical Part ; Walker, Political Economy, 3d. ed.. Part 
I. ; Hadley, Economics, chap. i. ; Pantaleoni, Pure Econom- 
ics, trans, by T. B. Bruce, Part I, chap. i. ; Marshall, Prin- 
ciples of Economics, 2d. ed., Vol. I., Bk. 1. ; Gide, Political 
Economy, trans, by E. P. Jacobsen, pp. 1-14 ; Ely, Otdlines 
of Economics, Bk. I., chapters x., xi.; Roscher, Principles of 
Political Economy, trans, by John J. L,alor, Vol. I., \\ 11-21. 



4 THEORY OF ECONOMICS 

body of knowledge which relates to wealth."^ But 
there is something even more fundamental to eco- 
nomics than wealth. Back of wealth, which is the 
immediate object of man's efforts, are the efforts 
themselves and the purpose for which they are put 
forth, i. e., the satisfaction of wants. Here is the 
fundamental fact in economics. Man is a creature 
of wants, which lead him to act that he may 
satisfy them. This should form the starting-point 
in the consideration of the phenomena that are 
commonly designated industrial or economic. It is 
the function of the economist to investigate the 
process through which men seek to secure the satis- 
faction of their wants, to the end that the principles 
involved may be discovered and explained. Econom- 
ics, then, may be defined as the science that treats 
of human activity in its relation to the pursuit of 
the satisfaction of wants. 

2. In this view of the nature of economics, the 
scope of the subject embraces all human activity, 
for every act has a want-satisfying phase, /. e. , every 
act is concerned with the process of satisfying 
wants, for every act has a want as its immediate 
cause. It is true that in some acts the want- 
satisfying phase is more apparent than in others, 
and those that show their economic character most 
prominently are usually selected as the material for 
investigation, for from such acts the principles of 
the economic process may most readily and certainly 

^Francis A. Walker, Political Economy, 3d ed., p. 8. 



ECONOMICS 5 

be discovered. Thus the activity of the carpenter, 
the farmer, the merchant, the manufacturer and 
others engaged in similar pursuits, is manifestly 
directed to the satisfaction of wants. No one ques- 
tions that such activity is economic, and it is with 
activity of this sort that economic investigation is 
chiefly concerned. 

It is, however, a mistake to suppose that only 
such acts as those mentioned possess an economic 
character. The activity of the philanthropist, the 
clergyman, the sister of mercy and others of like 
occupation, has an economic character as truly, if 
not as apparently, as the activity of the carpenter, 
the farmer, the merchant or the manufacturer, for 
the activity of the former callings proceeds from 
wants whose satisfaction is sought, as truly as does 
that of the latter. There may be, and doubtless 
are, wide differences between the two sorts of ac- 
tivity, but these differences lie, not in the fact that 
one is economic and the other is not, but rather in 
the character of the wants that give rise to the 
activity. 

3. The purpose of economic science, then, is to 
interpret the general truths of human activity in 
its relation to the pursuit of want-satisfaction. As 
such, it is not directly and immediately concerned 
with the formulation of precepts or rules of con- 
duct. This should be clearly understood. Other- 
wise the proper limits of the subject will not be 
recognized, and the true relation of economics to 
the problems of society will not be appreciated. 



6 THEORY OF ECONOMICS 

Injury has often resulted to the science and also to 
the cause of social advancement through failure to 
understand just what is to be expected of the sub- 
ject. Two facts need emphasis in this connection: 
(1) since economic theory is concerned with the 
principles that control in one of the most important 
phases of human activity, its conclusions, when 
valid, are indispensable to the solution of social 
problems ; (2) on the other hand, since economic 
theory treats of but one of the phases of human ac- 
tivity, it does not alone suffice for the solution of 
those problems. 

The attempt to prescribe for social ills without a 
knowledge of economic principles resembles the at- 
tempt of a physician to cure disease without a 
knowledge of the principles of materia medica or of 
some other branch of the science of medicine. By 
chance, he may apply the proper remedy, but the 
probability is that he will not, and that, if recov- 
ery follows his treatment, it will be due to the fact 
that the patient's constitution is able to withstand 
both the disease and the medicine. The much 
heralded panaceas for physical ills have their coun- 
terpart in many of the remedies proposed for social 
ills. Still, the presence of quacks does not discredit 
the real science of medicine in the opinion of 
thoughtful people, nor should the existence of social 
quacks discredit the essential truths of economics 
and the other social sciences or discourage the 
search for those truths. 

But, however important economic principles may 
be, since their scope does not include all phases of 



ECONOMICS 7 

human activity, they constitute but part of the 
equipment necessary to the solution of social prob- 
lems. In addition to these, such equipment re- 
quires a knowledge of the principles of moral obli- 
gation and of the nature and working of the will of 
society through the state. These three, economics, 
ethics and politics, considered as subjects which are 
concerned with the underlying principles of human 
activity in their respective fields, supply the essen- 
tial truths upon which sound social policies rest. 
The policy that is constructed in disregard of any 
one of them, must of necessity be ill-balanced and 
inadequate. 

4. The fact that economic theory is necessary 
to but not alone sufficient for the solution of social 
problems, has not always been recognized even by 
economists themselves. Too much has sometimes 
been claimed for economic theory, and when the 
expectations aroused have failed of realization, 
there have followed criticism and even denial of the 
value of the science. Two of these criticisms de- 
serve especial notice. Economics, in common with 
other subjects whose province is the discovery and 
interpretation of general principles, has been con- 
demned on the ground of a supposed fundamental 
inconsistency between theory and practice. And, 
again, the theory of economics has been subjected to 
the special criticism that its conclusions, if carried 
out, would be destructive of the welfare of society, 
since they disregard man's higher nature in their 
emphasis of his selfish impulses. 



8 THEORY OF ECONOMICS 

So far as the charge of an inconsistency between 
theory and practice is concerned in general, it is 
sufficient to say that this view rests upon a mis- 
taken conception of theory. Where such inconsis- 
tency really exists, it is not due to a fundamental 
lack of harmony between theory and practice, but 
to the shortcomings of the particular theory in 
question. Theory is nothing more than the interpre- 
tation of practice. There can, therefore, be no real 
inconsistency between a correct theory and practice. 

But of this criticism as urged against economic 
theory in particular, something more needs to be 
said. The objection in this connection has been 
directed mainly against the so-called orthodox or 
doctrinaire economics as set forth by the English 
writers, and the principal occasion for the criticism 
is the failure of the doctrine of laissez-faire or non- 
interference by government in business affairs, to 
meet the requirements of actual life. It should be 
said in passiijg that a careful reading of the leading 
representatives of the English school of economists 
fails to reveal any such hard and fast advocacy of 
laissez-faire as might be expected from the state- 
ments of some of their critics.^ But, admitting 
this, it remains true, doubtless, that some among 
the English writers show a tendency to restrict un- 
duly the sphere of governmental activit}' and to 
overestimate the importance of governmental non- 

1 Cf, John Stuart Mill, Principles of Political Economy, 
Vol. II., pp. 558, et. seq. 



ECONOMICS 9 

interference. One of the principal reasons for this 
attitude is found in the view entertained by those 
writers as to the part played by competition in the 
economic process, a fact that illustrates admirably 
the dangers of building theory upon inadequate hy- 
potheses. 

Free competition is probably the most funda- 
mental of the hypotheses upon which English eco- 
nomic theory rests. ^ Nor, indeed, is this view 
limited to English theory alone. In the prevailing 
treatment of the subject, the existence of competi- 
tion that is "full and free" is repeatedly set forth 
as a necessary condition for the validity of the con- 
clusions drawn. It is not surprising that such 
theory should prove inadequate as an interpretation 
of actual life. 

From a scientific standpoint, there is no objection 
to the formulation of a theory of human activity as 
it would be under a regime of free competition, pro- 
vided, of course, the reasoning remains consistent 
with that hypothesis. But a serious error follows 
when, without further qualification, the argument 
proceeds as though that which was assumed for the 
purpose of reasoning, corresponds with what exists 
in a normal society. This is exactly what much 

^ "Before commencing the inquiry into the laws of value 
and price, I have one further observation to make. I must 
give warning, once for all, that the cases I contemplate are 
those in which values and prices are determined by compe- 
tition alone." — J. S. Mill, Principles of Political Economy, 
Vol. I., p. 540. 



10 THEORY OF ECONOMICS 

of the current economic theory does. Starting with 
free competition as its fundamental hypothesis, it 
soon passes to the assumption, not only that such a 
condition is possible, but that it is the onlj^ normal 
and, therefore, the only healthy manifestation of 
economic activity. It is but a step from this con- 
clusion, to the inference that the economic ills of 
society are to be remedied by procuring the univer- 
sal swa}^ of free competition, an opinion which 
is widely prevalent. Such a theory is wholly 
irreconcilable with practice, for a condition of 
absolutely free competition does not and, as will 
be shown later, \>y the very nature of things can- 
not exist. ^ 

It is, then, doubtless true that the tenets of the 
English economists need revision in the light of 
later development and research. Such a result is 
entirely in accord with the evolutionary character 
of society. As time passes new conditions appear 
which call for interpretation and new light is thrown 
upon the fundamental principles of development 
themselves. This, however, is far from justifying 
the tendency that is shown by some to discard alto- 

^The criticism here made receives additional emphasis 
when, as not infrequently happens, even those who profess 
to rest their theory upon free competition, as a matter of 
fact do not, but proceed to limit the sway of competition 
arbitrarily as occasion requires. Moreover, in view of the 
important place given to competition in economic theory, it 
is a significant fact that one will search in vain in the vari- 
ous expositions of competitive economics for a comprehen- 
sive description of what free competition really involves. 



ECONOMICS 11 

gether the conclusions of English economics, and 
to construct the science anew. The attempt to do 
so has failed to produce anything of lasting value. 
A wiser course is to reexamine the hypotheses upon 
which that body of doctrine rests, with a view to a 
restatement of its principles where necessary. It 
may safely be affirmed that the teachings of Adam 
Smith, David Ricardo and John Stuart Mill supply, 
in the main, the foundation upon which any perma- 
ment addition to economic science will rest. 

5. The criticism passed upon economic theory 
that it inculcates selfishness, may be traced in part, 
at least, to the treatment of the economic process 
as though it were a distinct and wholly independent 
part of life. For, if a portion of men's acts are 
purely economic, it would seem to follow that, in 
directing such acts, only economic principles, i. e., 
such as are concerned immediately with want-satis- 
faction, need be considered. Here, too, it must be 
admitted there is much in the attitude of economists 
to warrant such a conclusion. When to this is 
added a narrow interpretation of want-satisfaction, 
which conceives it to be wholly selfish, the "dismal 
science" view of economics appears to be established. 
This criticism has exerted a marked influence upon 
the recent trend of economic thought, including 
much that is professedly concerned with funda- 
mental principles only. The attempt has been made 
to meet the difficulty by discarding the orthodox 
economics and substituting therefor a new system 
leavened with a modicum of ethics. Such a course 



12 THEORY OF ECONOMICS 

is apt to result in poor ethics and poorer economics. 
A remedj' of that sort is inadequate, because it does 
not touch the fundamental difficulty. It is the criti- 
cism that is here at fault; it fails to recognize the 
true scope and purpose of the science of economics. 

Bconomics, as a science, is concerned with what 
is, not with what ought to be. These are distinct 
inquiries. The question of ought arises as soon as 
the attempt is made to formulate a policy for so- 
ciety or for individuals in society. To be sure, the 
determination of what ought to be done to promote 
human welfare is the ultimate end of all serious 
study of social conditions. But the question of 
ought can not be determined satisfactorily without 
a knowledge of what is. This economics aims to 
ascertain in so far as the want-satisfying phase of 
activity is concerned. But the process of attaining 
want-satisfaction is not a separate and distinct 
sphere of life. Acts can not be sorted into distinct 
classes on the basis of their economic or non- 
economic character. As has been pointed out, 
economics treats of a phase of activity. It should 
not be difficult to recognize that the search for the 
principles which actually prevail in the effort of men 
to satisfy their wants, is far from identical with 
teaching that men ought to be concerned with their 
own welfare alone. 

Furthermore, the fact that ever)^ act arises from 
a want whose satisfaction it seeks, does not brand 
all action as selfish in the ordinary meaning of that 
term. Whether an act is selfish or not depends 



ECONOMICS 13 

Upon the kind of want that is back of it and the way 
in which its satisfaction is sought. Want-satisfac- 
tion is not necessarily selfish. Nor does the fact 
that economics considers action regardless of its 
selfish or unselfish character, signify that the 
science approves as right, conduct that is immoral. 
The man who takes advantage of another in a busi- 
ness transaction and then attempts to justify the 
proceeding on the ground that it is "business," has 
but a distorted notion of the relation of business 
and ethics. The science of physics is not con- 
demned as immoral because in accordance with 
physical laws, a man falling from the tenth story 
of a building upon a stone pavement is killed, nor 
is the science of chemistry held responsible for the 
aid that the would-be murderer derives from the 
chemical properties of arsenic. In following his 
good impulses and his evil impulses, man seeks the 
satisfaction of his wants ; so far as the science of 
economics is concerned, its scope is limited to an in- 
vestigation of the general principles involved therein. 
6. Economics is a social science because it is con- 
cerned with human activity and human activity is 
social. Though, under some circumstances, men's 
acts may seem to be purely individual, a closer view 
shows that they are never devoid of social character. 
Man himself is by nature social and cannot, if he 
will, escape the consequences of that fact. Hence, 
all of his activity is social activity in the sense that 
it is conditioned by society and that it in turn exerts 
an influence upon society. 



14 THEORY OF ECONOMICS 

As a social science, economics is closely related 
to certain other subjects which treat of social phe- 
nomena. First among the social sciences is soci- 
ology, which, as defined by Professor Giddings, 
is "the science of social elements and first prin- 
ciples."^ Following this is a group of subjects 
whose common starting-point is man's activity as a 
member of society. Fundamental in this group are 
the three subjects already referred to: economics, 
ethics and politics, treating respectively of activit}' 
in its relation to want-satisfaction, of moral obliga- 
tions and of the nature and manifestation of the 
social will through the state. In a manner grow- 
ing out of these are other related subjects, such as 
jurisprudence, which treats of the social will as 
manifested in law; finance, the theory of the sup- 
port of the state; administration, which investigates 
the methods of carrying out the will of the state; 
and others. 

7. With the subjects mentioned, two others, 
history and statistics, are often correlated. The 
domain of history is most comprehensive. In its 
broadest sense, it is nothing less than the record of 
the past. Restricted to society, it is the record of 
human development in all its phases. The philos- 
ophy of history is the theory of the progress of 
society. No investigation that seeks to understand 
the present condition of society and to provide for 
its future can be adequate if it disregards the facts 

1 The Prificip/es of Sociology, p. 33. 



ECONOMICS 15 

of social evolution. It is preeminently the province 
of history to interpret the development through 
which society has attained its present condition. 

Formerly there was a tendency to limit the scope 
of history to the political phase of social growth, 
but the view that "history is past politics and pol- 
itics present history" can be accepted, if at all, only 
in a very general sense. For as the truths of evo- 
lution have broadened the conception of human 
progress, it has come to be recognized that history 
belongs not to one phase of that development alone 
but to all phases. And from constituting a single 
and restricted field of investigation, history has 
come to be regarded as an essential feature of every 
department of social science. 

The science of statistics has grown out of a 
need for better methods of investigation. Theories 
based upon hypotheses evolved from the limited 
experience of one or of a few individuals have 
proven inadequate. The recognition of this fact 
led to a movement for the collection and systemati- 
zation of data on a large scale, and out of this has 
developed a new subject, statistics, which is essen- 
tially a science of method of investigation. It is 
described by Professor Meitzen as "the method of 
judging of collective phenomena from the results 
of enumeration."^ 

1 The History, Theory and Technique of Statistics, trans, 
by Roland P. Falkner. Supplement to the Annals of the 
American Academy of Political and Social Science, May 
1891, p. 107. 



16 THEORY OF ECONOMICS 

8. Varying opinions are entertained as to the 
validity of the claim of economics to be considered 
a science. The controversy is of importance only 
as it may help to give a clear understanding of the 
nature of the subject. The differences of opinion 
result largely from different views as to what con- 
stitutes a science. If the distinguishing character- 
istic of a science lies in the absolute and fixed nature 
of the phenomena with which it deals, economics 
is not a science. According to this standard, more- 
over, no subject that treats of man, whether con- 
cerned with his physical or mental nature, is a 
science. Indeed, this standard would exclude from 
the list of sciences all subjects that deal with life 
in any of its manifestations, including botany and 
zoology. 

A second criterion that may be taken for judging 
whether a subject is entitled to be called a science 
is the exact character of the results obtained. Ac- 
cording to this standard, also, economics is not a 
science. But if absolute exactness be insisted 
upon, it is doubtful whether any subject except 
mathematics can be called a science. Chemistry, 
physics and all subjects that involve measurement 
have their "probable error." 

A third feature that may be regarded as distin- 
guishing a science is the character of the subject as 
explaining homogeneous phenomena by the inter- 
pretation of their general truths. It is upon this 
basis that most of the so-called sciences rest their 
title to be thus designated. And according to this 



ECONOMICS 17 

standard, economics is properly included among the 
sciences. 

But whether, in the last analysis, economics is 
considered to be a science or not, scientific methods 
are indispensable to the discovery and interpreta- 
tion of the general truths in the phenomena with 
which the subject deals. Discriminating definitions 
are eminently desirable and logical consistency is 
essential. Much of the objection to the recognition 
of economics as a science is due, not to the nature 
of its phenomena, but to the unscientific methods 
of its exponents. And whether the attainment of 
exact results is possible or not, nothing can justify 
the failure to seek the highest degree of exactness 
that can be obtained. 



FUNDAMENTAL CONCEPTS 



Fundamental to the science of economics are 
four concepts, designated respectively, want, wealth, 
value and price. For the discussion of the prin- 
ciples of economics, it is especially desirable, at the 
outset, to formulate clear definitions of these con- 
cepts. Adequate definitions are indispensable to 
any scientific discussion, but their importance in 
economics is enhanced by the fact that the terms 

Clark, Philosophy of Wealth, chapters i., v.; The Dis- 
tribution of Wealth, chapter xxiv.; Pantaleoni, Pure Eco- 
nomics, trans., Part I., chapters ii.-v.. Part II., chapter 
i., \\ 1, 2; Von Wieser, Natural Value, trans, by C. A. 
Malloch, Books I., II.; Walker, Political Economy, l\ ^\h, 
114-118; Bohm-Bawerk, The Positive Theory of Capital, 
trans, by William Smart, Bk. III., chapters i., ii.; Marshall, 
Principles of Economics, Bk. II., chapter ii. ; Mill, Principles 
of Political Economy, Preliminary Remarks, Bk. III., chap- 
ters i., XV.; Sidgwick, The Principles of Political Economy, 
Bk. I., chapters ii., iii. ; Gide, Political Economy, trans., 
Bk. I.; Roscher, Political Economy, trans., §§ 1-10, 100; 
Ely, Outlines of Economics, pp. 89-93, 119-126, 141; Jevons, 
The Theory of Political Economy, pp. 40-90; Ivaughlin, 
Elements of Political Economy, chapters i., vii. 



FUNDAMENTAL CONCEPTS 19 

here employed are in common use without the care- 
ful distinctions essential to scientific analysis. 

9. An economic want is a desire that leads to 
activity. As has already been pointed out, the 
fundamental fact in economics is that every man is 
a creature of wants whose satisfaction he seeks. A 
man is hungry and wants food ; he is cold and 
wants clothing and shelter ; he possesses the capac- 
ity for knowing and wants instruction ; he appre- 
ciates the beautiful and wants paintings and statu- 
ary ; he is religious and wants the facilities for 
worship. Indeed the scope of this economic phe- 
nomenon is as broad and comprehensive as human 
activity itself. And since economics is the theory 
of human activity in its relation to want-satisfac- 
tion, wants, economically considered, are not limited 
to desires for material things, nor are the so-called 
ethical or philanthropic desires excluded. But 
these and all others that influence activity are prop- 
erly classed among economic phenomena. 

In considering the relation of wants to activity, 
it is necessary to distinguish between general wants, 
which are more or less intense but indefinite long- 
ings for things that may or may not exist, such as 
a general want for food, clothing or pictures; and 
specific wants, which are directed towards particu- 
lar objects, such as a want for definite articles of 
food, clothing or pictures that actuall)^ exist. The 
importance of this distinction lies especially in the 
close relation sustained by specific wants to wealth 
and value. 



20 THEORY OF ECONOMICS 

10. In the effort to attain the satisfaction of 
wants, specific things become the objects of wants. 
Thus, in seeking to satisfy hunger, commodities 
such as wheat, apples, sheep and others become 
wanted. These things constitute wealth, which 
consists of whatever exists and is the object of a 
want. When a thing becomes the object of a 
want, it may be said to possess the power of want- 
attraction, by which is meant merely that the 
thing attracts to itself a human want. Wealth, 
then, ma}' be defined to consist of whatever pos- 
sesses the power of want- attraction.^ Broad as 
this definition may seem, it is not essentially differ- 
ent from the popular conception of wealth. Houses 
and lands, wheat and com, cattle and sheep, pictures 
and statuary, — whatever in business intercourse is 
considered to be wealth, owes its designation as 
such to the fact that it is wanted. Some things 
that are wanted, it is true, are commonly excluded 
from the category of wealth. But when the reasons 

^ Every one who has discussed this subject has felt the 
need of a satisfactory term by which to designate that which 
constitutes the distinguishing characteristic of wealth. 
Though the idea itself is not difficult to comprehend, it 
is difficult to describe in a few words. The term "utility," 
commonly employed, results in confusion, because there is 
associated with it in the popular mind certain ideas, such as 
beneficial, that are not necessaril}^ connected with wealth. 
The expression, "power of want-attraction," is by no means 
free from objection, but its use in explaining the subject to 
students has shown that it conveys the desired information 
even thousjh it is somewhat cumbersome. 



FUNDAMENTAL CONCEPTS 21 

for such exclusion are ascertained, they are found 
to lie in the exigencies of the practical conduct of 
affairs; they are not valid for scientific purposes. 
Thus the popular view excludes from wealth those 
things whose power to attract wants is so small as 
to be "practically nothing." This suits the require- 
ments of business, but it does not suffice for eco- 
nomic science. As, in seeking mathematical truths, 
the infinitesimal can not be ignored, so, in seeking 
economic truths, the indefinitely small must not be 
discarded arbitrarily. 

11. For the existence of want-attracting power, 
and, therefore, of wealth, two conditions are essen- 
tial: (1) there must exist a want, and (2) there 
must exist something that is the object of that 
want. 

Supply or the mere existence of commodities is 
not of itself sufl&cient to result in power of want- 
attraction, for that power is not something that 
might exist if wants existed; it is something that 
actually does exist. A thing is not wealth simply 
because it might be wanted. For example, at one 
time cotton-seed, with the exception of the com- 
paratively small amount that was required for plant- 
ing, possessed no power to attract wants. Indeed, 
its presence diminished that power, because it was 
a hindrance to the utilization of the fiber. The 
necessity of separating it from the fiber and of dis- 
posing of it involved additional expense. But 
to-da)^ this is changed, and the power of cotton- 
seed to attract wants is great. Why? Not be- 



22 THEORY OF ECONOMICS 

cause cotton-seed has changed in its physical 
character, but because wants for it have developed. 
Cotton- seed oil and cotton -seed cake are in great 
demand. 

On the other hand, it is equally true that a want 
alone is not sufficient for the existence of want- 
attracting power. A want is merely an abstraction 
until it is directed toward some object. Men want 
food, but that does not signify that the power of 
want-attraction exists. The lonely wanderer in the 
desert on the verge of starvation wants food most 
intensely, but if there is no food, his want does not 
result in the existence of want-attracting power. 
True, a general want may lead to activity for its 
satisfaction and thereby occasion the production of 
a supply possessing want-attracting power, but this 
power actually exists only when the want and the 
thing come into relation with each other. It is not 
want for something in general, but want for some 
specific commodity that results in the power of want- 
attraction, and, therefore, in wealth. 

Furthermore, it should be observed in this con- 
nection, both that want for some specific commodity 
is necessary to the existence of wealth and that 
when want for some specific commodity exists, 
there is wealth. It may be that after the thing 
that was wanted is obtained and its true character 
ascertained, the want for it will cease. Then its 
power to attract want ceases, and with it its charac- 
ter as wealth. In other words, the possession of 
want-attracting power by anj^ thing does not involve 



FUNDAMENTAL CONCEPTS 23 

the actual usefulness of the thing for the purpose 
for which it is wanted. Whether ultimately adapted 
to one's needs or not, the fact that a thing exists 
and is wanted, is sufl&cient that for the time being 
want-attracting power, and, therefore, wealth 
should exist. 

12. The power of want-attraction must not be 
identified with physical properties, though its exist- 
ence may, in a sense, be due to such properties, 
i. e. , it may be because of its physical properties 
that a thing is wanted. But the power of want- 
attraction is not a physical property. Woolen gar- 
ments are able to give warmth, and possess the 
power to attract wants where warmth is desired. 
But this power to attract wants is not the physical 
property of the garment. If it were, the want- 
attracting power of the woolen garment would re- 
main the same so long as its physical character re- 
mained unchanged. But it is evident that this is 
not the case, for the power of woolen garments 
to attract wants is greater in cold than in warm 
climates; to those who know their capacity to warm 
than among those who are ignorant of it. 

It follows, too, from the nature of wealth, that it 
is not limited to tangible things. It includes the 
music of the singer as well as the piano of the 
manufacturer, for the former as well as the latter 
may possess the power of attracting wants. 

13. It is sometimes said that for a thing to be 
wealth it must be appropriable. It is undoubtedly 
true that if a thing is to continue to constitute 



24 THEORY OF ECONOMICS 

wealth it must be appropriable, in that it must be 
capable of serving the purpose for which it is 
wanted. Otherwise it will cease to be wanted and 
in that event it ceases to be wealth. Thus a sunken 
ship may be wanted until it is found that it can not 
be raised, after which there may be no want for it 
in the economic sense, /. <?. , no want that leads to 
activity, in which case it ceases to be wealth. But 
appropriability, as the term is commonly employed, 
is a characteristic or property rather than of wealth. 
Property involves ownership and implies the ability 
of the thing to be appropriated by an owner. It is 
a legal concept. A thing may be wealth, because 
the object of a want, even though legal ownership 
in it is impossible. 

14. The association of the ideas of wealth and 
propert}^ led to the view, at one time prevalent, 
that wealth consists chiefly in money, /. c, in an 
instrument which enables its possessor to obtain 
property in commodities. But the wealth of society 
is not necessarily increased by an increase in 
mone^^ nor by an increase in such things as bonds, 
mortgages and other similar instruments of ex- 
change and evidences of ownership. For it is 
evident that if every indi\'idual in society were to 
execute to another individual a mortgage, the 
wealth of society would not be increased by the 
amount of these mortgages. And, if the govern- 
ment were to start its printing presses and turn 
out an unlimited quantity' of paper money in 
denominations of dollars, the wealth of the country 



FUNDAMENTAL CONCEPTS 25 

would not be increased by that number of dollars, 
each having the present value of a dollar. The 
reason for this lies in the fact that there would 
be little or no want for such mortgages and such 
dollars. 

The recognition of the fact that the mere increase 
in money, mortgages and similar commodities does 
not necessarily increase the wealth of society, has 
led to another view which goes to the opposite ex- 
treme and denies to these the character of wealth. 
There is here a failure to distinguish between the 
existence of wealth and the amount of wealth. It 
does not follow that, because under certain condi- 
tions an increase in instruments of exchange and 
evidences of ownership does not increase the wealth 
of society, these things never constitute wealth. If 
society were to proceed to make its entire supply of 
iron into saws, the wealth of society would not be 
increased proportionately. Indeed, it is quite con- 
ceivable that a point would be reached where an 
increase in saws would actually decrease the supply 
of wealth, the number being so far in excess of the 
want therefor that the saws would be worth less 
than the raw materials used in making them. Saws 
are wealth only in so far as they possess the power 
to attract wants. In like manner, in so far as 
money and mortgages possess the power to attract 
wants, they are as truly wealth as the tool which, 
by facilitating the cultivation of the soil, assists in 
the production of food, or the machine which, by 
sawing lumber, increases the power of wood to 



26 THEORY OF ECONOMICS 

attract wants. A society without instruments of 
exchange would have less wealth than a society 
which possessed them. 

15. In investigating the process of pursuing the 
satisfaction of wants, it becomes necessary to deter- 
mine quantitative conditions. This gives rise to 
questions of value, for value is the amount of the 
power of want-attraction possessed by any commod- 
ity. Value is the quantity of that characteristic 
which constitutes a thing wealth. Wealth, power 
of want-attraction and value are related as thing, 
characteristic and amount of that characteristic, so 
that value is inseparable from wealth and wealth is 
inseparable from value. 

16. Many wants are common to more than one 
member of society, from which it follows that the 
objects of wants are often sought by different indi- 
viduals. Moreover, wants differ in degree of in- 
tensity. Two persons may possess commodities of 
such a character that each will prefer what the 
other has to that which he himself has. In such 
an event, the two persons will probably exchange 
their commodities, for, other things being equal, 
every man seeks that which has for him the great- 
est power of want-attraction. Hence, many com- 
modities have what is called "power-in-exchange," 
i. e., they have the power to secure for their posses- 
sor other commodities in exhange for them. But 
"power-in-exchange" is not essential to value ; that 
is to say, it is not necessary that two persons should 
want a commodity in order that value should exist. 



FUNDAMENTAL CONCEPTS 27 

A thing does not cease to have value, simply be- 
cause it comes into the possession of the only per- 
son that wants it and thereby ceases to have 
"power-in-exchange," for it does not cease to have 
value so long as it has the power to attract a want. 
On the contrary, it is want-attracting power which 
gives "power-in-exchange," for all things that pos- 
sess "power-in-exchange" have want-attracting 
power, as is evidenced by the mere fact of exchange, 
which implies that the thing exchanged is wanted. 
Value, then, does not depend upon "power-in-ex- 
change," but "power-in-exchange" depends upon 
value. 

17. Some things are commonly said to have a 
large amount of power to attract wants but no 
value, because, though of great usefulness, they 
are so plentiful. Thus, air, light, water and other 
commodities of like character are said to possess no 
value (except under special circumstances when 
they may be scarce and difl&cult to obtain) though 
their power to attract wants is very great. Ac- 
cordingly, it is held that scarcity is essential to 
value. But scarcity is a purely relative matter and 
influences the degree of want- attracting power pos- 
sessed by a commodity, not the existence of that 
power. A thing may have more or less value be- 
cause it is more or less scarce, but the existence of 
value depends upon the existence of want-attracting 
power, not upon scarcity. 

To say that water has no value though its want- 
attracting power is great, involves, from an eco- 



28 THEORY OF ECONOMICS 

nomic standpoint, two errors. In the first place, it 
misconceives what the power of want-attraction 
really is. When water is said to have a large 
amount of power to attract wants, it is meant that 
water is very beneficial. But want-attracting power 
and power to benefit are not identical, unless it be 
held that a man is benefited by whatever will at- 
tract his wants, a proposition to which few will 
agree. A thing might possess much want-attract- 
ing power with but little or no capacity to benefit, 
because it might be wanted very much despite 
its comparative uselessness ; and, vice versa, a 
thing might possess but little want-attracting 
power with much capacity to benefit, because, 
though capable of doing much good, little want 
for it existed. 

Again, when it is said that water has much 
power to attact wants, the supply of water in 
general is thought of, and when it is said that water 
has no value, a small portion of the supply is 
thought of. There is here a confusion of general 
and specific wants. In the case of any given amount 
of water, as for example a given cupful, its value 
may be very small, but its want-attracting power is 
also, in that case, very small, /. e., the want for that 
cupful is small. 

On the other hand, to deny that value exists in 
such a case, because the amount is insignificant for 
practical purposes, leads to some remarkable con- 
clusions from the scientific point of view. Thus, 
according to that theory, a grain of wheat has no 



FUNDAMENTAL CONCEPTS 29 

value, but a large number of grains, enough, say, 
to make a bushel, have value. Yet the bushel of 
wheat is only the sum of the number of grains 
which compose it. This method of reasoning finds 
something by adding together a limited number of 
nothings and is invalid in economics as well as in 
mathematics. If air, light, water and similar com- 
modities possess want-attracting power, they must 
have value, because value is merely the amount of 
such power and there must be some amount where 
the power exists. 

18. The amount of want- attracting power pos- 
sessed by a commodity at any time, i. e., the value 
of the commodity, is found by measuring that 
value. Value when measured is expressed in terms 
of the measure or unit of comparison, and this ex- 
pression is price. Price, then, may be defined as 
value expressed in terms of a measure. Though 
there is nothing abstruse or difficult of comprehen- 
sion about the nature of value and price and their 
relation to each other, no other concepts in eco- 
nomics are more often misunderstood, few are used 
with so little attempt at accurate distinction and 
none is a more prolific source of error. Their im- 
portance to economic discussion rather than any ex- 
ceptional difiiculty in comprehending them, necessi- 
tates their consideration in greater detail. 

To understand price and to appreciate its signifi- 
cance, one must understand the process of measur- 
ing value, for it is by measuring value that price is 
found. This, in turn, requires a knowledge (1) of 



30 THEORY OF ECONOMICS 

what it means to measure and (2) of what it is that 
is to be measured.^ 

19. To measure is to compare quantities. The 
operation involves the selection of a unit or measure 
and the comparison of the thing to be measured 
with the measure. The selection of a measure'^ 
consists in choosing a definite amount of some spe- 
cific thing possessing the quality or property that is 
to be measured. This selection of a measure is 
purely a matter of choice, except only that the 
thing selected must possess the quality or property 
that is to be measured, /. e., a measure of length 
must have length, a measure of weight must have 
weight, and a measure of value must have value. 
Having selected a measure, the remainder of the 
process of measuring consists in determining the 
quantitative relation between the measure and the 
thing to be measured. Take for example the process 
of measuring length. As a first step, a definite 
amount of something having length is selected as a 
unit or measure. Convenience will dictate that 
the measure be neither too long nor too short, 
but all that can be said to be absolutely essential to 

1 Measuring value is one of the most common phenomena 
in the economic process. Whenever an exchange is made 
or, indeed, whenever one thing is preferred to another, value 
is measured. But notwithstanding the frequency of the 
operation and its importance, it is one of the least compre- 
hended of all phases of economics, and misconceptions con- 
cerning it are responsible for a multitude of fallacies. 

2 The popular term "measure" is employed in the main in 
this discussion instead of the scientific term "unit." 



FUNDAMENTAL CONCEPTS 31 

the measure is that it should have length. The 
amount selected is purely a matter of choice. To 
facilitate measuring, society adopts standards for 
general use, which are designated by some special 
name, such as, in the case of measures of length, a 
"foot," a "5^ard," or a "metre." But the measure 
used in any instance may be some convenient 
length adopted for the occasion, as when a gar- 
dener, desiring to make the sides of a bed equal, 
takes as his unit or measure a certain distance on 
his hoe handle. Even where society adopts stand- 
ard measures, it remains true that the size of those 
measures in the first instance was purely a matter 
of choice. And though the existence of such 
Standards may be eminently desirable for social in- 
tercourse, and though they are so commonly used 
that one seldom thinks of their having been selected 
arbitrarily, still, as a matter of fact, they are in no 
way an absolutely indispensable requisite to the 
process of measuring. 

Having settled upon the measure of length to 
be used, a comparison is made between it and the 
thing to be measured in order to determine the 
quantitative relation between the lengths of the two 
objects. The result of the comparison is a ratio. 
It is found that the length of the thing measured 
bears a certain relation to the length of the meas- 
ure. Thus, if a foot is the measure, and the re- 
sult shows that the object measured, say for ex- 
ample a board, is twenty feet long, this means that 
the length of the board is twenty times the length 
of that which is called a foot. 



32 THEORY OF ECONOMICS 

The result of the measurement will be more or 
less precise, according to the invariabilty of the 
measure and the care exercised in making the com- 
parison. Thus one may pace a j5eld to determine 
its length, and since a pace is subject to variation 
in length, the result will give but an approximately 
precise idea as to the length of the field. Or, in 
measuring with a yard-stick, the operation may be 
carelessly performed, with but an approximate re- 
sult. Still, these comparisons are measurements 
regardless of their precision. To measure is to com- 
pare quantities, and all quantitative comparisons 
are measurements. 

20. The second requisite for an understanding of 
the process of measuring value is a clear compre- 
hension of what it is that is to be measured. The 
nature of value has already been described, but its 
essential characteristics may well be emphasized 
anew in this connection. The value of a commodity 
is the amount of its power to attract wants, or, if 
being wanted may be called a property of a com- 
modity, the value of a commodity is the amount of 
its property of being wanted, just as the length of 
anything is the amount of its property of extension. 
In measuring value, a comparison is instituted be- 
tween two commodities to determine the relative 
degrees of intensity with which they are wanted, 
i. e., how the amount of the want-attracting power 
of one compares with the amount of the want-at- 
tracting power of the other. 

To illustrate, suppose it is desired to measure 
the value of a horse. First, something possessing 



FUNDAMENTAL CONCEPTS 33 

want-attracting power is arbitrarily selected as a 
unit or measure. This measure may be anything 
having value. Some things are more convenient 
than others for use as measures of value, but the 
possession of value, /. e. , of some power of want- 
attraction, is the only absolutely indispensable 
requisite of a measure of value. The measure se- 
lected in this instance may be a sheep. A compari- 
son is then made between the want-attracting power 
of the horse and of the sheep. As a result, it may 
be found that the want for the horse equals the 
want for 50 sheep. Then the value of the horse 
has been measured and found to be equal to the 
value of 50 sheep. Here, then, is price. The price 
of the horse is 50 sheep. This is the value of the 
horse expressed in terms of the measure, sheep. 
Or, the measure adopted may be a definite quantity 
of some metal, say 23.22 grains of gold. A com- 
parison may show that the want for the horse 
equals the want for 2,322 grains of gold. The 
value of the horse then equals the value of 2,322 
grains of gold. The price of the horse is 2,322 
grains of gold.^ 

^In ordinary business intercourse, the terms "value" and 
"price" are often used interchangeably, as when one asks, 
"what is the value of a horse" or "what is the price of a 
horse," but in scientific discussion the distinction between 
the two concepts should be carefully observed. Thus in the 
above illustration, it would commonly be said that the value 
of the horse is 2,822 grains of gold, but accurately speaking, 
it should be said that the value of the horse is equal to the 
value of 2,322 grains of gold, or that the price of the horse 
is 2,322 grains of gold. 



34 THEORY OF ECONOMICS 

As in the case of length and weight certain 
amounts are selected as measures and called a foot, 
a pound, etc., so in the case of value, that which is 
selected as a unit or measure may be designated by 
some special name, such as a dollar, a pound or a 
franc. Thus the measure selected ma^^ be 23.22 
grains of gold and this may be called a dollar. 
Then, in the case of the horse above mentioned, it 
would be said that the price of the horse is 100 dol- 
lars, but this is only another way of saying that 
the want for the horse equals the want for 100 of 
those things which are called dollars. 

Nor is the correctness of this in any wise affected 
by the fact that no two persons may agree that the 
value of the horse is equal to the value of fifty 
shfeep or of 2,322 grains of gold or of whatever 
may be taken as the measure. This would mean 
merely that in no two persons was the relative in- 
tensity of the want for the horse and for the sheep 
the same. Herein lies the chief difference between 
measuring such properties as length and weight 
and measuring value. In the former, the property 
measured is constant or nearly so; in the latter, it 
is variable. The length of a given field is the same 
at all times; the same is true of the length of a 
given foot. But the value of a horse is variable, 
and so also is the value of whatever may be selected 
as the measure of value. This fact has important 
consequences, but it should not be allowed to ob- 
scure the fact that whether length, weight or value 
is considered, the process of measuring is the same, 



FUNDAMENTAL CONCEPTS 35 

in that in all cases measuring is comparing amounts 
of similar qualities, and that whenever such com- 
parisons are made they are measurements. 

21. All measurements give a two-fold result. To 
compare one thing with another, involves comparing 
the other with the one. Thus, if a room is meas- 
ured and found to be twenty feet long, it follows 
that a foot is one-twentieth the length of the room. 
So in the case of the horse, if its value equals the 
value of fift}'- sheep, it follows that the value of a 
sheep equals one-fiftieth the value of the horse. 
The price of the horse is fifty sheep; the price of a 
sheep is one-fiftieth of the horse. Hence two 
prices result from all measurements of value. This 
fact is obscured in ordinary business transactions 
by the custom of selecting definite quantities of one 
or more commodities, usually metals, as standards 
by which to measure values, and the designation of 
these measures by some special name not suggestive 
of the object itself. But it is evident that, if the 
measure is 23.22 grains of gold, called a dollar, it 
follows that when the price of twenty pounds of 
sugar is a dollar, the price of a dollar, or of 23.22 
grains of gold, is twenty pounds of sugar. 

Price, then, is the value of a commodity ex- 
pressed in terms of some other commodity with 
which it is compared to determine the quantitative 
relation of the values of the two commodities. In 
other words, price is value expressed in terms of a. 
measure. 



THE LAW OF VALUE 



22. The basis of value is power of want-attrac- 
tion. By basis of value is meant that upon which 
value depends, and it follows from the concept of 
value set forth in the definition, that want-attract- 
ing power is the basis of value. But it is necessary 
to emphasize this fact so that there may not fail a 
clear distinction between the true basis of value 
and certain other economic phenomena, which, even 
when indispensable to value, are not in themselves 
the cause of value. 

It is sometimes said that labor is the basis of 
value. But value does not exist merely because 
labor has been expended, even though some labor, 
if only that of appropriation, is necessary to the 

Walker, Political Economy, ?§ 119-128; Ely, Outlines of 
Economics, Bk. II., Part II., chapter ii.; Gide, Political Econ- 
omy, trans., pp. 47-68; Clark, Philosophy of Wealth, chapter 
vi. ; Ivaughlin, Elem,ents of Political Economy, chapter x. ; 
Mill, Principles of Political Economy, Bk. III., chapters 
ii.-vi.; V. Wieser, Natural Value, trans., Bks. I., II.; 
Bohm-Bawerk, Positive Theory of Capital, trans., Bk. III.; 
Pantaleoni, Pure Economics, trans.. Part II., chapter 
iii.; Marshall, Principles of Economics, Bk. III. 

3(3 



THE LAW OF VALUE 37 

existence of value. Hence the amount of want- 
attracting power possessed by a commodity does 
not correspond to the amount of labor that has been 
expended upon it, nor does its value bear any neces- 
sary quantitative relation to the amount of labor 
expended. Indeed, labor is often expended with- 
out resulting in value at all, because no one 
desires that which is produced or because nothing 
is produced. 

According to another but similar view, cost of 
production is the basis of value. There are wide 
differences of opinion as to what is meant by cost 
of production. But it is not the basis of value ac- 
cording to any of the views entertained as to its 
nature, even though in the production of want- 
attracting power there must be some cost, however 
slight. The objections to this view are substantially 
the same as those in the case of the labor theory.' 
Expenditure of energy does not necessarily result 
in value. If the product is not wanted, it has no 
value, however large its cost may have been. Hence 
value does not depend upon the cost of production, 
although under some circumstances, as will be seen 
later, the two may sustain an important relation to 
each other. 

23. Value results from the want for a specific 
commodity. To discover, then, the principles gov- 
erning value, the want-attracting power of a specific 
commodity must be the object of consideration. 
This specific commodity constitutes a definite por- 
tion of the supply of that commodity, and may be 



38 THEORY OF ECONOMICS 

designated a unit of supply. The conditions de- 
termining the want for a unit of supply are: (1) 
the intensity of the demand for the kind of com- 
modity in general, and (2) the number of units or 
the supply of the commodity.^ 

That the intensity of the demand for a given 
kind of commodity will affect the want for a unit 
of the supply of that commodity is evident. The 
want for a unit of the supply of bread, say a loaf, 
will differ with different degrees of hunger and 
with different degrees of liking for bread as an 
article of food. A loaf of bread, if sold to the high- 
est of several bidders having equal ability to pur- 
chase, would be shown to be wanted more by one 
of the number who was starving or who found 
bread a desirable sort of food, than by one whose 
hunger had recently been satisfied or who had diffi- 
culty in digesting bread. 

But the want for a specific loaf of bread will be 
influenced also by the number of loaves available, 
for this determines the ease or difficulty with which 
another loaf can be obtained. And the more easily 
another can be secured, the less intense will be the 
desire for the specific loaf in question. Though a 

1 In speaking of units of suppl}', it is assumed that all are 
of the same quality. So far as economic science is concerned, 
differences in quality constitute different kinds of commod- 
ities. No. 2 wheat is a different kind of commodity from 
No. 1 wheat as truly as corn is a different kind of commodity 
from wheat, though the degree of difference between the 
former is not so great as between the latter. 



THE LAW OF VALUE 39 

man were so hungry that he would give a dollar 
for a loaf of bread rather than go without it, the 
want- attracting power of a given loaf is not equal 
to that of a dollar, if the supply of loaves is so 
abundant that another can be secured for five cents. 
The want for a given unit of bread is not large, no 
matter how hungry the man or how excellent the 
bread, if another loaf can easily be obtained. 

It follows then that the greater the demand with 
a given supply, the greater is the want-attracting 
power of a unit of that supply, and, vice versa, the 
less the demand, the less is the want- attracting 
power of a unit. And, on the other hand, the 
greater the supply of a commodity, with a given 
demand, the less is the want-attracting power of a 
unit, and, vice versa, the less the supply, the greater 
is the want-attracting power of a unit. Value, 
then, is determined by the relation of supply and 
demand. 

The supply of a commodity is the amount 
that is available for meeting wants. But the want 
for a commodity may be due to a desire to provide 
for the future, and the intensity of the want for an 
existing unit of supply may be influenced by the 
prospective ease or difficulty with which the com- 
modity can be secured in the future, i. e. , the value 
of a given unit of supply depends in part upon 
prospective supply. Moreover, not all portions of 
the supply of a commodity actually in existence 
exert the same influence upon value. That which 
is kept out of the market in anticipation of a higher 



40 THEORY OF ECONOMICS 

price does not influence value the same as that 
which is offered for sale. A distinction may, there- 
fore, be made between active and potential supply, 
the former including all of a commodity that is ac- 
tually available at a given time and the latter, that 
which is prospectively available. 

A similar distinction may be made between active 
and potential demand. Some wants, though satisfied 
at times, recur. Moreover, changes in conditions, 
such as a decrease in prices, may lead wants that 
were dormant to manifest themselves. The wants 
that actually seek satisfaction under given condi- 
tions constitute active demand, while those wants 
which may become active constitute potential de- 
mand. 

The fact that the active supply and demand 
may increase and decrease because of changes in 
price, may appear to contradict the statement that 
value depends upon the relation of demand and sup- 
ply. A decrease in price may result in the with- 
drawal of some of the supply or in the addition of 
some demand ; while an increase in price may re- 
sult in the increase of supply or decrease of de- 
mand. From this it appears to be possible that de- 
mand and supply are determined by value through 
price, instead of value being determined by demand 
and supply. The contradiction is, however, but 
apparent. It is future demand and supply that are 
influenced by movements in price. The value at 
anj^ given time depends upon the relation then ex- 
isting between demand and supply. 



THE LAW OF VALUE 41 

24. From the fact that value is determined by 
the relation of demand and supply, it follows that 
value is subject to variations when changes occur 
in that relation. A change in the relation of de- 
mand and supply occurs whenever there is a change 
in either demand or supply which is not exactly 
offset by a corresponding change in the other. 
Moreover, changes in the relation of demand and 
supply are the rule rather than the exception. The 
supply of commodities seldom, if ever, remains con- 
stant, and even though it did for a time, if a change 
occurred in wants, this would change the relation 
of demand and supply and result in a variation in 
value. 

It will be observed, also, that whenever the 
change in the relation of demand and supply is due 
to an increase in demand or to a decrease in supply, 
i. e. , whenever the change is an increase in relative 
demand or a decrease in relative supply, the value 
of a unit increases. And, conversely, whenever 
the change in the relation of demand and supply is 
due to a decrease in demand or to an increase in 
supply, i. e. , whenever the change is a decrease in 
relative demand or an increase in relative supply, 
the value of a unit decreases. That is to say, vari- 
ations in value move in the same direction as varia- 
tions in demand and inversely to variations in 
supply. 

This statement as to variations in value per- 
tains to the value of units of supply rather than to 
the value of the entire supply. As to what effect 



42 THEORY OF ECONOMICS 

variations in supply will have upon the value of the 
total supply, no universal principle can be laid 
down beyond this ; whether an increase or a de- 
crease in the number of available units of supply 
will cause a corresponding or a converse movement 
in the value of the entire supply, depends upon the 
effect of the variation in the supply upon the value 
of a unit. An increase in supply might so far de- 
crease the value of a unit as to decrease the value 
of the total supply ; on the other hand, a decrease 
in supply might increase the value of a unit to such 
an extent as actually to increase the value of the 
total supply. For example, an increase in dia- 
monds, by making them common, might so decrease 
the demand as to diminish the value of the total 
supply of diamonds, while a decrease in their sup- 
pi}^ might have an opposite effect. The value of 
the total supply of a commodity depends upon the 
value of a unit and the number of units. 

25. The principles which govern in the deter- 
mination of value and in variations in value are 
sometimes combined and called the law of value, 
which may be thus stated: Value is deterviined by 
the relation of demaiid and supply and varies because 
of variations in demand or supply, moving in the 
same direction as demand and inversely as supply. 
The importance of this law to the interpretation of 
economic phenomena and to the formulation of 
precepts for the control of the economic affairs of 
society can hardly be overestimated, and calls for 
a correct understanding of its exact content. 



THE LAW OF VALUE 43 

It is sometimes inferred that, because variations 
in value are due to variations in supply or demand, 
there is a definite quantitive relation between 
changes in supply or in demand and changes in 
value. According to this view, if the supply of a 
commodity doubles the value of a unit of the supply 
decreases one-half, and if the supply of a com- 
modity decreases one-half, the value of a unit 
doubles. Such a conclusion is false and is in no 
way involved in the law of value. The extent to 
which a change in supply will affect value depends 
upon the status of the want for the commodity. If 
before the change in supply, nearly all the want for 
the commodity was met, a given increase in supply 
will cause a relatively large decrease in the value of 
a unit, because such an increase in supply will 
enable a unit of the supply to be obtained much 
more readily. On the other hand, if an increase in 
supply finds a large unsatisfied want awaiting it, 
the result of such an increase in supply will be a 
very slight fall in the value of a unit. In like man- 
ner, a decrease in supply will cause a large or small 
increase in value according to the accompanying 
status of the want. The nature of the want, the 
availability of other commodities which may be 
substituted for the one in question, and many other 
conditions enter to determine to what extent changes 
in supply will affect the value. Moreover, varia-. 
tions in the supplies of different commodities do 
not necessarily nor probably cause the same degree 
of variations in the values of the two commodities. 



44 THEORY OF ECONOMICS 

The attempt to formulate a statement of the quanti- 
tive relation between variations in supply and varia- 
tions in value can not succeed so long as the phe- 
nomena of human wants elude the efforts to discover 
in them uniformly constant tendencies. 

It should be noted, too, in this connection, that 
variations in the annual output of commodities do 
not indicate the extent of variations in the supply 
of commodities, except when the commodities are 
of such a character that each year's supply is con- 
sumed annually. Thus to compare changes in the 
supply of wheat and of gold by comparing the 
annual output of these commodities involves a seri- 
ous error. The annual product of gold, silver and 
other similar commodities but adds to a supply 
that is already large, whereas the annual product of 
wheat, potatoes and commodities similar to these, is 
approximately a renewal of the supply. 

26. Price is value expressed in terms of a meas- 
ure, hence the price of any commodity is the ratio 
of its want-attracting power to the want-attracting 
power of the commodity with which it is compared. 
It follows, then, that the price of a commodity will 
fluctuate with changes either in the amount of its 
want-attracting power, i. <?. , its value, or in the 
amount of the want-attracting power, /. e., the 
value, of the commodity which serves as a measure. 
Thus if the value of a pound of sugar is equal to 
the value of one-half a 3-ard of cloth, the price of a 
pound of sugar is one- half a yard of cloth. Now, 
if either the value of the pound of sugar changes, 



THE LAW OF VALUE 45 

without a corresponding change in the value of 
cloth, or the value of a yard of cloth changes 
without a corresponding change in the value of 
sugar, there results a change in the price of sugar 
in terms of cloth. Suppose, for example, that 
the value of sugar doubled, the value of cloth re- 
maining the same, then the value of a pound of 
sugar would be equal to the value of a yard of 
cloth, and the price of a pound of sugar would be 
one yard of cloth. In like manner, if the value of 
cloth increased, say to double its former amount, 
the value of sugar remaining unchanged, then the 
value of a pound of sugar would equal the value of 
a fourth a yard of cloth, and the price of a pound 
of sugar would be one-fourth a yard of cloth. 

But, as has been seen, value is subject to varia- 
tions because of changes either in the supply of 
a commodity or in the demand for it. Since, then, 
the price of a commodity is dependent upon the re- 
lation of two values, each of which is subject to 
variation because of changes in supply or demand, 
it follows that price is subject to variation from the 
four following causes : (1) from variations in the 
supply of the commodity itself or (2) in the de- 
mand for it, or (3) from variations in the supply of 
the commodity taken as a measure, or (4) in the de- 
mand for that commodity. Thus an upward move- 
ment in the price of a commodity will result from 
an increase in the demand for it, or from a decrease 
in the supply of it, or from a decrease in the de- 
mand for the commodity that serves as a measure. 



46 THEORY OF ECONOMICS 

or from an increase in the supply of that com- 
modity. A fall in price will result from any one of 
the four converse changes in demand and supply. 

From the nature of price and its relation to value, 
it follows also that a movement in the price of one 
commodity involves a movement in the price of the 
commodity that serves as a measure, and that these 
movements are in opposite directions. Thus an up- 
ward movement in the price of one commodity re- 
sults from an increase in the ratio of its value to 
the value of a second commodity, with which the 
first is compared. But this involves a decrease in 
the ratio of the value of the second commodity to 
the first, and, therefore, a fall in the price of the 
second commodity in terms of the first. If the 
price of sugar in terms of cotton goes up, the price 
of cotton in terms of sugar goes down, and vice versa. 

The dependence of price upon the supply of 
and demand for commodities and the two-fold na- 
ture of price fluctuations are often unperceived be- 
cause of the method by which prices are fixed in 
business transactions. For prices do not move up 
and down like mercury in a thermometer as the 
result of physical changes and exactly coincident 
with them. Prices are fixed through the medium 
of human judgment, so that actual changes in sup- 
ply and demand affect values and, therefore, prices, 
only as they affect the judgments of men. More- 
over, though the method of fixing prices consists 
at times in the bidding by purchasers, who offer 
more or less according to their judgment as to the 



THE LAW OF VALUE 47 

conditions of supply and demand, more often the 
method employed consists in offering a commodity 
at a price fixed by the seller, who increases or de- 
creases the price according to his opinion of the 
conditions as revealed by the intensity of the de- 
mand. But it is not the less true in this case that 
prices depend upon the relation of demand and sup- 
ply, for the intensity of demand which determines 
whether the seller will alter the price, varies with 
the supply believed to be available. 

Moreover, the suppl}'^ of commodities is itself not 
a purely spontaneous matter, but is the result, to 
some extent, of men's judgment. The supply ac- 
tually available depends in part upon the amount 
actually produced and in part upon the disposition 
of the owners thereof to part with it. Self-evident 
as this is, it requires mention, for it is too often 
assumed that the normal economic process consists 
merely in producing commodities and placing them 
on sale for what they will bring, whereas man's 
judgment, as he seeks the maximum of want- 
satisfaction, affects not only what is produced, 
but where and when and how it is disposed of. 
And the results of judgment as to the disposal of 
commodities are quite as important to the economic 
process as the results of judgment are to what 
shall be produced. 

27. The relation of the law of value to price has 
been illustrated by examples in which prices are de- 
termined by comparing the values of commodities 
with each other directly, without the use of a stand- 



48 THEORY OF ECONOMICS 

ard measure of value. The introduction of a stand- 
ard measure of value, though of great importance 
to economic activity, in no way alters the funda- 
mental principles according to which prices are de- 
termined. A standard measure of value is a definite 
amount of some specific commodity whose value 
society decrees shall be considered constant in the 
settlement of contracts; that is to say, in enforcing 
the fulfillment of contracts, society requires the 
pa3^ment of a definite amount of the commodity 
which is recognized as the standard, or its equiva- 
lent in value, taking no account of variations in 
the value of ' that commodity, which result from 
changes in the relation of demand and supply. The 
employment of the standard in measuring values is 
not usually compulsory. The values of commodi- 
ties may be compared with each other directly, as 
is sometimes done in trading horses for example, 
or the)' may be compared with any other commodity 
which may be agreed upon. But when society is 
called upon to enforce the fulfillment of a contract, 
it estimates the obligation involved by comparison 
with the standard measure and requires payment 
accordingly. 

The use of a standard measure tends to con- 
ceal the real nature of the process of measuring 
value, for its employment results in the determina- 
tion of the relation of the values of commodities by 
comparing each with a third commodity instead of 
with each other, except when the commodity which 
serves as the standard measure is one of the two 



THE LAW OF VALUE 49 

directly concerned. And it may be that the in- 
dividual who makes the measurement (comparison) 
in any case is not aware of the use of the com- 
modity that is the standard measure, the first steps 
in the process and the function of the standard 
measure being lost to view in the complexity of the 
operation. The comparison of value in any given 
case may be made by the use of something other 
than the standard, whose value has been determined 
in the first instance by comparison with the 
standard measure. 

When to this is added the fact that in expressing 
value, the special name given to the standard meas- 
ure is used, instead of the name of the commodity, 
the mystery of the process is increased. Thus in 
the United States, at the present time (1901), the 
standard measure is 23.22 grains of gold. This is 
called a dollar. In considering the purchase of a 
hat whose value is estimated to be equal to that of 
46.44 grains of gold, and whose price accordingly is 
said to be two dollars, an individual compares his 
want for the hat with his want for something else, 
say a pair of gloves, whose price is also two dollars. 
As a matter of fact the prices of the hat and gloves 
were determined in the first instance by a compari- 
son of their values with the value of 23.22 grains 
of gold, or, perhaps, by comparison with something 
else whose value had been compared with the value 
of gold. For that matter, the estimate of the rela- 
tion of the values of the hat and gloves to the 
value of gold may have been reached by any num- 



50 THEORY OF ECONOMICS 

ber of intermediate measurements, and throughout 
the operation no one may have been aware of the 
fact that he was making a measurement. The 
measurement may have been accomplished merely 
as a result of the choice of this or that thing in 
preference to another. To the person considering 
the relation of his want for the hat to his want for 
the gloves, expecting probably to pay for one or the 
other with dollars of paper or of silver, the function 
performed by the 23.22 grains of gold does not 
appear, and he comes to view a dollar as standing 
for an absolute amount of value, quite apart from 
its connection with an}- particular thing, a condi- 
tion which further consideration shows to be an im- 
possibility. 

Still another source of confusion is found in 
the fact that society may recognize in law more 
than one standard measure, calling them all by 
the same name, and leaving it to individuals to use 
whichever they prefer. Thus, if society so decrees, 
the standard measure may be 23.22 grains of gold, 
371.25 grains of silver, and anything else having 
value, even a promise to pay whose value will de- 
pend upon the confidence of the people in it. Each 
of these niaj^ be called a dollar. But it does not 
follow that the values of these several dollars will 
be equal. Whether they are or not will depend 
upon whether their respective povv^ers to attract 
wants are equal. A community might have several 
John Smiths, but they would not necessarily have 
anything in common except their name. Exactly 



THE LAW OF VALUE 51 

the same is true when society recognizes several 
standards of value and calls them by the same 
name. A dollar is not a definite amount of value; 
it is a definite amount of some commodity or com- 
modities, to which that name is arbitrarily given 
and the values of which depend upon the relation 
of the supply thereof to the demand therefor.^ 

28. As has been seen, a movement in price may 
be due to causes affecting the commodity directly 
or to causes affecting the commodity which serves 
as a measure. In any given case it is impossible to 
determine to which of these the movement in price 
is due, except in so far as the conditions of supply 
and demand in their relation to the commodities 
can be determined. In measuring value it is as- 
sumed that the value of the measure is constant, 
but this assumption may be contrary to fact, for the 
value of the measure is dependent upon the relation 
between the supply thereof and the demand therefor, 
the same as are the values of other commodities, and 
those conditions are subject to variation. This fact 
receives added importance from the widespread but 
erroneous belief that when society selects a definite 
amount of some commodity as a standard measure 
of value, it fixes not only the amount of the com- 
modity which is to be recognized as a standard, but 
also the value of that commodity as well. But so- 

1 It is not to be inferred from the above statement that it 
is a matter of indifference what or how mauj^ standards of 
value society adopts. That is a matter which belongs to the 
discussion of the money problem. 



52 THEORY OF ECONOMICS 

ciety's refusal to take account of fluctuations in the 
value of its standard when contracts are enforced, 
does not make the value of the standard constant. 
If society's recognition of some commodity as a 
standard measure of value affects the relation of 
the supply of that commodity to the demand there- 
for, the act of society affects the value of that com- 
modity. But so long as society can not absolutely 
control both supply and demand, it can not abso- 
lutely fix values. 



THE ECONOMIC PROCESS 



29. The efforts of men to satisfy their wants 
taken in their entirety constitute the economic 
process, which may be defined as the totality of 
human activities in their relation to the pursuit of 
the satisfaction of wants. Rightly viewed, this 
process constitutes a whole composed of many 
parts. A due recognition of this fact is absolutely 
essential to the attainment of valid economic prin- 
ciples. The nature of the process will be better 
understood by considering the general character of 
the activity of which it is composed, the normal 
manifestations of that activity, the conditions es- 
sential to progress and the steps in the process. 

Ely, Monopolies and Trusts^ chap. i. ; Competition : its 
Nature, its Permanency, and its Beneficence, in publica- 
tions of the American Economic Association, Third Series, 
Vol. II., p. 55; Sidgwick, The Principles of Political 
Economy, Bk. II., chap, x.; Mill, Principles of Political 
Economy, Bk. II., chap, xvi., \ 2 ; Baker, Monopolies and 
the People ; Jenks, The Trust Problem; Walker, Political 
Economy, § 129 ; Clark and Giddings, The Modern Dis- 
tributive Process, chap. ii. ; Laughlin, Elements of Political 
Economy, \ 94. 

58 



54 THEORY OF ECONOMICS 

30. In seeking the satisfaction of wants, as in all 
other manifestations of his nature as a human 
being, man acts as a member of society. That is 
to say, in their economic pursuits, men sustain 
relations to each other, and as the distinguishing 
characteristic of society is relationship, men are 
social beings economically as in other respects. It 
will not suffice, then, to isolate acts for the study of 
their characteristics and from such study to formu- 
late general principles. To learn the true signifi- 
cance of any act, it must be observed not only by 
itself but also in relation to other acts. For no act by 
itself reveals its full economic significance, its com- 
plete bearing upon the satisfaction of wants, because 
it is not without influence upon other acts. Though 
some may seem to be concerned only with the 
individual who performs them, they are never 
wholly devoid of social character. This fact can 
never safely be lost to sight in economic investiga- 
tions. True, the economic process as a whole is a 
more or less intangible affair. Men seldom think 
of the social character of their efforts. An individ- 
ual turns his activity in this or in that direction 
because he believes that the course selected will 
best conduce, under the circumstances, to the satis- 
faction of his desires. He may be and usually is 
wholly unaware of the fact that his choice has been 
determined in no small degree by other conditions, 
and that his own act, which .seems to have but 
slight consequences apart from himself and at most 
his immediate neighbors, is in fact part of a whole 



THE ECONOxMIC PROCESS 55. 

and in vital relation with it. But, though the 
activities which constitute the economic process 
present themselves as individual matters, when one 
passes from the visible and apparent to inquire as 
to causes and effects, the true character of individ- 
ual action as part of an organic whole becomes 
evident. 

On the other hand, activity possesses an indi- 
vidual, as well as a social character. The economic 
process manifests itself in the form of the activity 
of individuals; its ends are realized through the 
efforts of individuals to satisfy their wants. In the 
last analysis, social activity is but the activity of 
individuals. Hence economic activity is individual 
activity; economic conditions are the result of indi- 
vidual conditions ; and economic progress, if realized 
at all, is attained only when individual activity, 
directed primarily from the individual's standpoint 
and for individual ends, is so ordered as to promote 
the efficiency of the process as a whole. 

Nor is this true only in the case of such activity 
as purports to be directed towards private ends. 
The activity which is professedly aimed at the 
attainment of social ends is after all individual 
activity and the ends sought are individual ends in 
that they are an individual's idea of social ends. 
The difference between the activity of the philan- 
thropist and that of the manufacturer, in their rela- 
tion to the general welfare, is primarily a difference 
in the conscious motive which each sets before him, 
rather than in the method of attaining the common 



56 THEORY OF ECONOMICS 

good. There is or may be a wide difference be- 
tween the wants of the two, but the activity of each 
is individual activity; it follows in both cases from 
individual judgment; and, in the case of the manu- 
facturer as well as of the philanthropist, there is a 
vital relation between the individual act and the 
economic process as a whole. The extent to which 
each promotes the general good depends upon the 
harmony existing between the individual choice and 
the reqirements of that general good. Whether 
the result of the action of the philanthropist will in 
the end be promotive of the progress of society can 
not be foretold with greater certainty or complete- 
ness than can the results of the acts of the manu- 
facturer or of any other person, whose conscious 
motives seem to center directly upon self. 

Individual activity, then, is the immediate object 
of economic investigation. But to understand indi- 
vidual activity and especially to arrive at conclu- 
sions which will have more than a passing signifi- 
cance, individual activity must be considered both 
in its social and in its individual character. 

31. The question as to what sort of activity is 
normal to the economic process is one of the first 
inquiries that arise when the attempt is made to 
discover the principles which govern in that process. 
To determine what constitutes normal economic 
activity, it is necessary to ascertain the conditions 
essential to the attainment of the satisfaction of 
wants, for that which is inseparable from success in 
the effort to satisfy wants must be considered nor- 



THE ECONOMIC PROCESS 57 

mal to the process. Observation of the process 
shows that success in securing the satisfaction of 
wants requires (1) that the obstacles to want- satis- 
faction be surmounted, and (2) that the individual 
possess such economic strength as will enable him to 
surmount those obstacles. Self-evident and even 
commonplace as these facts maj^ seem, they are of 
great importance to economic theory. From these 
two essentials to success it follows that the activity 
of an individual seeking want-satisfaction will be 
directed both towards surmounting the obstacles in 
the way of the satisfaction of wants and towards 
acquiring the economic strength necessary thereto. 
Turning to actual experience, it is seen that this is 
just what men do. 

But these two aims are closely related. Though 
they may present themselves to individuals as dis- 
tinct, as a matter of fact they are by no means 
independent of each other. For, it will be observed, 
it is by surmounting obstacles and securing the 
satisfaction of wants that economic strength is 
acquired, and it is by acquiring economic strength 
that one is able to surmount the obstacles to want- 
satisfaction. In other words, every act, viewed 
from the standpoint of its economic significance is 
at once an effort to surmount obstacles to the satis- 
faction of wants and an effort to acquire economic 
strength which makes possible the surmounting of 
obstacles. 

32. The importance of the above conclusion be- 
comes especially marked when considered in its 



58 THEORY OF ECONOMICS 

bearing upon the activity of men in society. Here 
rivalry appears betv^een individuals, because the 
attempt to satisfy wants gives rise to conflict of 
interests. Thus men appear as rivals in endeavor- 
ing to secure trade, in seeking employment, in 
bidding for contracts, in settling upon terms for the 
division of the results of a common enterprise, and 
in many other vv^ays. Rivalry of interest leads to 
contest; this, as an economic phenomenon, is called 
competition, v^^hich may be defined as the contest 
between rival interests among members of society in 
the pursuit of the satisfaction of their wants. Though 
the existence of competition in many instances may 
be seen and the parties thereto easily recognized, 
competition is not limited to such cases. For a 
rivalry of interests often exists and influences activ- 
it}^ without a definite knowledge on the part of 
those concerned as to who their rivals are or as to 
the exact nature of the rival interests. In fact, 
there is rivalry of interests wherever the effort by 
one to satisfy his wants interferes with the efforts 
of another. 

Viewed in relation to the efforts of individuals to 
secure the satisfaction of their wants, rival interests 
present themselves as obstacles to the accomplish- 
ment of that end. From the standpoint of individ- 
uals, then, competition is the effort to surmount the 
obstacles to the satisfaction of wants, which are 
involved in rival interests among members of soci- 
et5^ As thus described, competition is a normal 
economic phenomenon, and the activity involved in 



THE ECONOMIC PROCESS 59 

competition must be considered normal, because it 
arises naturally from the attempt of individuals 
as members of society to satisfy their wants. 

Activity is directed also to acquiring eco- 
nomic strength, without which obstacles could not 
be surmounted and wants would remain unsatis- 
fied. This appears, for example, in the attempt 
of individuals to collect enough of the neces- 
saries of life to make them independent of 
unforeseen accidents; it appears also in the 
effort to obtain such tools and other instruments 
as may enable one to secure the satisfaction 
of his wants more efficiently. It may manifest 
itself in the efforts of an individual to secure to 
himself alone the economic strength which will 
enable him to surmount opposing obstacles, or it 
may consist in the union of the forces of several to 
the end that the combined strength may be able to 
accomplish that for which the strength of each by 
himself is inadequate. Moreover, economic strength 
may result either from a union of forces which in- 
volves a definite agreement or from a common 
policy which arises merely from the recognition by 
each that his interests will be promoted by acting 
in accord with others. There is doubtless great 
difference in the permanence and efficacy of the two 
methods of securing common action, but to the 
extent that they are effective, each gives to those 
concerned increased economic strength. Indeed, 
the common policy is not necessarily a conscious 
one. Economic strength is developed wherever men 



60 THEORY OF ECONOMICS 

act in harmony with each other instead of in antag- 
onism to each other. But whether economic 
strength results from the efforts of individuals by 
and for themselves alone or from the working 
together of several to secure the advantage that 
comes from united effort, and whether the united 
effort results from a specific agreement or from the 
common impulse of those concerned, the fundamen- 
tal character of the phenomenon is the same. It is 
concentration of economic power. 

Economic strength gives power of control over 
the conditions for success in the satisfaction of 
wants. When this affects the relation of men in 
society, it becomes monopolization, which may be 
defined as power of co7itrol in the contest between rival 
interests. From the standpoint of the individual, 
monopolization is the concentration of economic 
strength which enables one to oppose the rival 
interests that are an obstacle to the satisfaction of 
his wants. As such, monopolization, like competi- 
tion, is a normal economic phenomenon, and the 
activity aimed at the attainment of monopolization 
must be considered normal, for it also arises natu- 
rally and necessarily in connection with the efforts 
of individuals as members of society to satisfy their 
wants. 

33. Both competition and monopolization are 
associated with rivalry of interests in society. The 
former is the attempt to surmount the obstacles to 
want-satisfaction which result from rivalry; the 
latter is the concentration of economic strength 



THE ECONOMIC PROCESS 61 

which is necessar}^ to oppose rival interests. But, 
as has been seen, the surmounting of obstacles and 
the concentration of economic strength, though 
they may appear as distinct aims, are in fact inter- 
dependent, and are features of every economic 
act. The satisfaction of wants which results from and 
can be attained only by surmounting obstacles, is 
the condition requisite to the acquirement of eco- 
nomic strength, which in turn is the condition 
requisite for surmounting obstacles. From this it 
follows that competition and monopolization sustain 
a close relation to each other. These phenomena 
are, in fact, attendant upon all activity which in- 
volves the rivalry of members of society in the 
effort to satisfy their wants. 

From the nature of competition and the con- 
ditions under which men act, it results that there 
is always some competition, because rivalry of 
interests always exists, but /r.?^ competition is im- 
possible. Competition means contest between men. 
Free competition, then, means unrestricted contest 
between men, and the conditions for such contest 
do not exist. For competition to be unrestricted, 
the equipment of men for contesting must be equal, 
else one of the parties will achieve success and the 
other will lose his ability to compete and competi- 
tion will cease. The inequalities among men are 
themselves insuperable obstacles to free competi- 
tion. 

Furthermore, for competition to be absolutely free, 
not only must men meet on equal terms in the con- 



62 THEORY OF ECONOMICS 

test, but their resources for maintaining the contest 
must be unhmited, else the contest will be carried 
to a finish and cease because of exhaustion. But 
the resources which enable men to contest with 
rivals are limited and this limits freedom of compe- 
tition. Indeed, nature itself places restrictions 
upon competition through limitations in the sup- 
ply of commodities and of the means for pro- 
duction. The extent of the limitations varies. 
There are wide differences in the degree of compe- 
tition at different times and under different circum- 
stances. It may be moderate or it may be intense, 
but it can never be full and free, i. e. , it can never 
be unrestricted. 

It was at one time supposed that the only 
impediment to free competition consisted in legisla- 
tive enactments, which secured advantages to some 
at the expense of others. Accordingly it was be- 
lieved that the repeal of those enactments, leaving 
men on equal terms before the law, would insure 
entire freedom of competition. But it has come to 
be realized that freedom from legislative control is 
at best negative freedom, and that true freedom 
involves much more. 

It follows, furthermore, from the nature of 
monopolization and the conditions under which it 
appears that the element of monopolization is 
always present but absolute monopolization is impos- 
sible. It is necessary to distinguish here between 
power of control over specific commodities and power 
of control in the contest between rival interests. 



THE ECONOMIC PROCESS 63 

though the two are closely related. A large degree 
of power of control over commodities is given by 
the mere fact of ownership. But the effect of own- 
ership upon the relation of men in society varies 
greatly under different circumstances. On the one 
hand, it is evident that the mere fact of ownership 
confers upon the owner some power of control in 
his contest with rivals, and this power of control is 
monopolization, be it ever so small. Indeed, so 
long as contest between rivals exists in society the 
element of monopolization can never be wholly 
wanting, for some power of control is inseparable 
from such contests. But however absolute and 
extensive ownership may be, neither it nor any 
other condition can confer upon one absolute power 
of control in the contest with rivals. There is 
always a limit beyond which no man can control 
others and make them subservient to himself. As 
in the case of competition, there are wide differ- 
ences between the degrees of monopolization in 
different cases. In many instances, it is so slight 
as to be of little, if any, practical moment, while in 
others it may be so great as to be fraught with most 
serious consequences. But absolute monopolization 
cannot exist. ^ 

The foregoing analysis of the nature and per- 
sistence of competition and monopolization is of 
the highest importance to the interpretation of the 
economic process. For, if free competition is im- 

1 See Pt. III., iii. Exchange. 



64 THEORY OF ECONOMICS 

possible, an economic theory which rests upon its 
assumed existence cannot be an adequate interpre- 
tation of human activity in its relation to want- 
satisfaction. On the other hand, if monopolization 
is inseparable from the association of men for eco- 
nomic ends, the economic theory which treats it as 
incidental and temporary must also be inadequate. 
Moreover, the view of competition and monopoliza- 
tion here presented has more than a theoretical 
importance. Influenced largely by the teachings of 
economics, the opinion prevails very generally that 
the ideal condition of society is one in which com- 
petition is full and free and that in some way or 
other such a condition is attainable. Hence efforts 
are directed towards the realization of that end. 
Thus far the results obtained give but little hope of 
success and many persons, in despair, are inclined 
to extreme measures. The practical bearing of the 
conclusions here reached is to be found in their 
teaching that social evils, in so far as they result 
from either competition or monopolization, are to 
be remedied by such measures as will prevent them 
from becoming excessive rather than by attempts 
to eradicate them, for their eradication is impos- 
sible without destroying society itself. 

34. The fundamental condition of all progress is 
that the fittest should survive and become more fit. 
If the opposite were true, if the less fit survived 
and became, as time passed, less fit, not only would 
there be no progress, but there would be actual ret- 
rogression. It is because in farming, in manufac- 



THE ECONOMIC PROCESS 65 

turing, ill commerce, and, indeed, in all spheres 
of activity, better methods supplant poorer, that 
society progresses in economic efficiency. Horse- 
power has been supplemented and for some pur- 
poses supplanted by steam-power; the stage-coach 
and sail-boat have in large measure given place to 
the railroad and steamboat; after the sickle came 
the cradle, then the reaper, the self-binder and 
finally the combination harvester, which cuts, 
gathers and threshes. 

In this respect economic progress but shares in 
the condition necessary for development of any sort. 
Even moral progress is attained only through the 
survival of the fittest and its increasing fitness. 
Higher concepts of rights and duties pervade soci- 
ety, taking the place of such as are inferior — only 
thus does one age become better than its predeces- 
sor. Rights of life, of family, of property, of 
speech, of free-movement, of self-government, — in 
all of these, as history shows, higher and broader 
ideals have supplanted lower and narrower ones and 
a better civilization has resulted. 

35. The process of selection by which the survival 
of the fittest is realized involves a contest. The 
old does not give place to the new without a strug- 
gle. Indeed, it may be that fitness can be deter- 
mined only by a contest. In society this contest 
involves rivalry of interests among its members, 
for it is alwa3^s to the immediate or apparent inter- 
est of some that the old should continue, and to the 
interest of others that the new should be substituted 



66 THEORY OF ECONOMICS 

for the old. This contest is competition, and here- 
in appears the fundamental reason for its existence, 
— its purpose in the economic process. Competition 
is one feature of the process of selection. It is 
through competition that the fittest supplants the 
less fit, hence competition is absolutely essential to 
progress. 

But the survival of the fittest is not accomplished 
through competition alone. If the fittest is to 
supplant the less fit, it must possess power of con- 
trol sufficient to enable it to carry on the contest 
and to win. This power of control is monopoliza- 
tion. Herein lies the importance of monopolization 
to economic progress. It performs a function in 
the economic process as essential as that of compe- 
tition. Monopolization enables the contest to be 
carried on by which the less fit is supplanted. 

In addition to the services mentioned, com- 
petition and monopolization render others, in that 
each tends to counteract the evils of excess in the 
other. Competition is strife and strife, if car- 
ried too far, becomes exhausting. Competition 
is not an end in itself; it is a means to an 
end, the survival of the fittest. To prevent 
competition from defeating its own end, through 
exhaustion of energy, there must be such power of 
control as will prevent the contest from being too 
long continued. Monopolization, then, besides 
making possible a contest with rival interests, 
affords the power of control necessary to prevent 
exhaustion. 



THE ECONOMIC PROCESS 67 

But the mere possession of power of control does 
not insure progress. To accomplish this, the 
power must be used. Without activity power of 
control results in stagnation and deterioration. 
That which is necessary to call power of control 
into activity, is contest with rival interests, i. e., 
competition. Competition, then, not only aids 
in the survival of the fittest, but prevents that 
which survives from becoming less fit through 
stagnation. 

The view here presented of the nature of com- 
petition and monopolization and of the function 
performed by them in the economic process, may 
seem at first to be wholly at variance with the 
view of these phenomena commonly entertained. 
Further examination, however, will show that 
whatever of difference exists, is due in part to the 
fact that the popular view rests upon a superficial 
analysis of the economic process and in part to an 
unscientific use of terms. The statement that the 
primary service of competition is to aid in securing 
the survival of the fittest is reflected in the popular 
dictum that "competition is the life of trade." The 
further fact that competition is not necessarily a 
a blessing, that its excess may mean decreased eco- 
nomic efficiency, is a truth already recognized by 
the popular mind, and one that is beginning to 
affect economic theory. 

In the case of monopolization, the difference 
between the view here presented and popular opin- 
ion is greater than in the case of competition. As 



68 THEORY OF ECONOMICS 

yet but little attempt has been made to analyze the 
economic process for the purpose of ascertaining 
the place of monopolization therein. A good and 
a bad side to concentration of strength are recog- 
nized by society substantially as in the present 
analysis, but on its good side the concentration of 
energy is called "cooperation" or the "growth of 
large industries," while on its bad side it is called 
"monopoly." But the phenomena described by 
these terms are inseparable. Both "cooperation" 
and the "growth of large industries" involve an 
increase in the power of those concerned to con- 
trol the conditions of success in the contest with 
rivals. 

Moreover, the popular view considers the element 
of monopolization to be present only when power 
of control is so extensive that the welfare of society 
is believed to be endangered by it; while the present 
analj'sis insivSts on recognizing the phenomenon of 
power of control and on calling it by the same 
name, regardless of its amount. It requires but 
slight consideration to see that the essential charac- 
ter of monopolization, even in the popular view, is 
power of control. But power of control is relative 
and should be recognized as such wherever it is 
found. 

36. In the economic process as society is now 
ordered, there are two steps; — (1) the correlation 
of things and wants to bring into existence want- 
attracting power and (2) the division of this want- 
attracting power among members of society. The 



THE ECONOMIC PROCESS 69 

first of these steps is called production. If in the 
economic process each man acted wholly by himself, 
there would be but this one step. But in society men 
combine their forces to render them more efl&cient. 
From this, there arises the necessity of dividing the 
results of production among the members of society. 
This step is called distribution. Before wants are 
satisfied a third step is necessary, i. e., the actual 
application of things to wants. But this, the con- 
sumption of commodities, lies outside the scope of 
economic investigation, except in so far as it affects 
production and distribution. 



PART II 



PRODUCTION 



PRODUCTION 



37. The process of correlating wants and things 
has been described as the first step in the general 
economic process. This, as has been said, is the 
production of wealth. It consists in bringing 
wants and things into such relation that want- 
attracting power results, and may be accomplished 
in either of two ways: (1) by the adaptation of 
things to wants and (2) by the adaptation of wants 
to things. The former is the production of supply; 
the latter is the production of demand. 

In its ordinary forms, the process of produc- 
ing a supply of wealth is easily recognized. The 
farmer plows, sows and reaps, and there is produced 
grain, which as food nourishes man; or fibres, 
which, made into textiles, protect and adorn him. 
The miner drills and blasts, and there is produced 

Sidgwick, The Principles of Political Economy, Bk. I., 
chap, i.; Ely, Outlines of Economics, Bk. II., Part I., chap, 
i. ; Mill, Principles of Political Economy, Bk. I., chapters 
iii., xii.; Walker, Political Economy, §§45, 46, 49-53; Laugh- 
lin. Elements of Political Economy, chapters ii., iii.; Mar- 
shal, Principles of Economics, Bk. IV., chapters ii., xiii. 

73 



74 THEORY OF ECONOMICS 

fuel, which warms the body or aids in generating 
power. The carpenter saws, planes, and fits, and 
there is produced a dwelling-house or a factory. 
But productive activity is not limited to assisting 
nature to bring forth commodities nor to changing 
the forms of materials in order to adapt them to 
wants. It includes also the activity engaged in 
transporting, storing, exchanging and otherwise 
making available that which may attract wants. 
The farmer, mechanic and miner produce wealth; 
and so also do the carrier, the merchant and the 
banker, because the latter, as truly as the former, 
are engaged in forms of activity which increase the 
power of want-attraction. For, in order that a 
commodity should be able to attract wants, it is 
necessary (1) that it possess the requisite phys- 
ical properties; (2) that it have the desired 
form; (3) that it be at the place where it is wanted; 
and (4) that it exist at the time when it is 
wanted. He who sows and cultivates aids in bring- 
ing together the requisite physical properties. He 
who grinds the wheat or saws the log or hammers 
the iron aids in gi^dng proper form to commodities. 
That these are engaged in producing wealth is 
evident. But the railroad employees from presi- 
dent to section-hand aid in placing commodities 
where they are wanted. So also do the merchant 
and the banker. These, then, produce wealth as 
truly as do the farmer or the mechanic, for it is 
fully as important to the existence of want- attract- 
ing power that things should be where thej- are 



PRODUCTION 75 

wanted as that they should have the requisite phys- 
ical properties and form. In addition to this, the 
merchant, whether jobber or retailer, aids in mak- 
ing commodities available when they are wanted. 
This also is a feature of the production of a supply 
of wealth. He who keeps ice from winter, when 
it is wanted but little, until summer, when the 
want for it is intense, produces wealth just as truly 
as the miner who digs coal and aids in bringing it 
to the surface. The same is true of all who by 
Storing commodities keep them until the want for 
them increases and they come to have an increased 
want-attracting power. The production of wealth 
is not the mere production of commodities, it is the 
production of want- attracting power. 

Furthermore, as has been pointed out, wealth 
does not consist wholly of tangible things. Hence 
the production of wealth is not limited to those 
forms of activity that are expended upon tangi- 
ble things. The singer who meets the want for 
music produces wealth. So also does the scholar 
searching out truth and contributing to the sat- 
isfaction of the desire for knowledge; likewise 
the judge, deciding controversies and enunciating 
the principles according to which peaceful associa- 
tion is promoted; and the clergyman, ministering to 
man's religious wants. It might be maintained 
that these are producers of wealth even if the con- 
ception of wealth were limited to tangible things, 
because such persons indirectly increase the effi- 
ciency of the activity engaged in producing tangi- 



76 THEORY OF ECONOMICS 

ble wealth. This, however, is but a partial view. 
The wants which come within the scope of eco- 
nomics are not simply such as are centered upon 
tangible things but include all that pertain to 
human nature, and every act that contributes to 
the production of that which will attract human 
wants, is part of the productive process. 

The process of production is commonly thought 
of as consisting only in the production of sup- 
ply, i. e., in the adaptation of things to wants, 
lyittle attention has been given in economic theory 
to the other phase of the process, the production of 
demand, though in practice this phase of the proc- 
ess is by no means neglected. That wealth is pro- 
duced, /. e., that want-attracting power is created 
by the development of demand is attested by the 
facts of every day experience, where the develop- 
ment of demand gives want-attracting power to 
that which before did not possess it or increases 
that power in commodities which already possess it 
in some degree. An example of this is found in 
the case of cotton-seed already mentioned, where 
that which was an obstacle to the satisfaction of 
wants was changed into a serviceable commodity 
by the development of a demand for it. No small 
part of the energy expended in business is directed 
towards the development of demand. 

38. From an economic standpoint, an expendi- 
ture of energy is productive whenever it results in 
the existence of want-attracting power and unpro- 
ductive only when it fails to accomplish that 



PRODUCTION 77 

result. A view sometimes held limits productive 
activity to such as results in the production of so- 
called material wealth.^ But such a concept is 
both unscientific and unfortunate in its practical 
effects. If wealth consists of whatever possesses 
want-attracting power, effort should be considered 
unproductive only when no want-attracting power 
results therefrom, i. e., when there results neither 
a supply of something that is wanted nor a demand 
for something that exists. The designation of effort 
as productive only when it results in material 
wealth, tends to overestimate the importance of 
such effort in comparison with that which is not 
expended upon material commodities. And, how- 
ever distinctly those who hold such a view of the 
difference between productive and unproductive 
effort, may declare that productive in this sense is 
not synonymous with useful, it is difficult to avoid 
leaving the impression that what is unproductive is 
useless. 

39. While, however, an expenditure of energy is 
not to be classed as unproductive so long as want- 
attracting power results, there are, wide differences 
between the relation of returns to outlay under 
different conditions, and these have an important 
influence upon the activities of men. Thus it is 
evident that in such an industry as farming, the 
amount of wheat that any given acre will yield 
does not depend merelj^ upon the energy expended. 

1 Mill, Principles of Political Economy, Bk. I., chap, iii., 
?§ 1-4. 



78 THEORY OF ECONOMICS 

It may be that where an acre has yielded 6 bushels, 
the application of double the amount of energy will 
produce 12 bushels or even more, and that another 
proportional increase in outlay will produce 24 
bushels or more. But there is a limit beyond which 
such results cannot be obtained. If an acre pro- 
duces 75 bushels with a given expenditure of 
energy, double that outlay will not give 150 bushels. 

The principle involved has been formulated as 
follows: — in the production of commodities, condi- 
tions arise in which an added expenditure of energy 
will not give a proportional increase in returns. 
This is called the law of diminishing returns. 
Though the limits of the operation of this law have 
not been definitely determined, it is generally be- 
lieved that it applies especially to the production of 
raw materials, to the so-called "extractive" indus- 
tries.^ But since all industries are dependent in 
some degree upon raw materials, the influence of 
the principle reaches with greater or less force 
throughout the entire range of industrial under- 
takings. 

On the other hand, there are many instances 
in which the returns of an industry can be increased 
without a proportional increase in outlay of energ3^ 
Thus a railroad, once built and equipped, can under 
some conditions double its carrying capacity with- 
out necessitating a correspondingly increased out- 
lay. A second track can be built, the necessary 

1 Walker, Political Economy, p. 35, et seq. 



PRODUCTION 79 

rolling stock and other equipment added and a 
sufl&cient force of employees provided without re- 
quiring twice the expenditure for the original road. 
The same is often true of manufacturing enter- 
prises. The principle here involved constitutes the 
law of increasing returns and is the converse of the 
law of diminishing returns. It may be thus stated: — 
in the production of commodities, conditions arise 
in which increased returns do not require propor- 
tional increase in expenditure of energy. As in 
the case of the law of diminishing returns, the 
limits of the operation of this law have not been 
definitely ascertained. In general, it seems to de- 
pend largely upon the extent to which human in- 
telligence can offset the limits placed by nature upon 
the increase of wealth. 

The laws of diminishing and of increasing re- 
turns are of special importance in their relation to 
the possible growth of population and the develop- 
ment of the standard of living. To the extent that 
the law of diminishing returns prevails, the possi- 
ble increase of population and advance in the stand- 
ard of living are limited. Should this law be 
ignored and the birth-rate increase to the full limit 
of the procreative capacity of mankind, the ulti- 
mate result would be the reduction of the standard 
of living approximately to the level of mere animal 
existence. There might even be a suppression of 
the growth of population, for the maintenance of 
population depends upon the food supply, and should 
this be inadequate, the increase in the death-rate 



80 THEORY OF ECONOMICS 

would tend to offset the effect of the birth-rate on 
the growth of population. The influence of the 
law of diminishing returns is counteracted in some 
degree by the operation of the law of increasing 
returns, but to what extent this can be carried is 
uncertain. Though the present rapid increase in 
the efl&cienc}' of the productive process may appear 
to render the influence of the law of diminishing 
returns upon population and the standard of living 
comparatively unimportant, the possible future con- 
sequences of the operation of that law, in view of 
the tendency of population to increase, makes its 
recognition b}' economic theory imperative. 

The laws of diminishing and increasing returns 
are of importance also in their relation to the work- 
ings of competition and monopolization. Where 
the law of increasing returns is operative it tends 
to increase the power of control of those in whose 
favor it operates, especiall)'' as compared with the 
power of those who produce subject to the law of 
diminishing returns, for in production under the 
law of increasing returns, the cost per unit of prod- 
uct decreases when the amount produced increases, 
while the converse is true in production under the 
law of diminishing returns, — here the cost per unit 
of product increases when the amount produced in- 
creases. And he who produces at lower cost than 
his rivals, possesses a greater power of control in his 
contest with them. This is especially significant 
in its relation to rivalry in the exchange of com- 
modities, where, as will be seen later, the posses- 



PRODUCTION 81 

sion of power of control enhances the ability of one 
to obtain the means for satisfying his wants. 

40. The object of an analysis of the process of 
production is to ascertain the conditions upon which 
efficienc}' in this part of the economic process 
depends. The inquiry here is not concerned 
with the technique of specific industries such as 
farming, engineering, weaving and building, but 
only with those general principles which control in 
the production of the means for the satisfaction of 
wants. Fundamentally speaking, it may be said 
that since the production of wealth consists in pro- 
ducing a supply of commodities or a demand for 
commodities, the efficiency of the process of produc- 
tion depends upon the conditions requisite for 
efficiency in these two directions. The question, 
then, may be thus stated: — (1) given wants, how 
can the commodities necessary for their satisfaction 
be produced most efficiently, and (2) given com- 
modities, upon what does the efficiency of the 
production of a demand therefor depend. 

An analysis of that phase of the process of 
production which aims to provide a supply of com- 
modities shows that efficiency here depends upon 
(1) the factors of production, (2) the economic 
organization and (3) the incentive to activity. 

The factors of production are situation, capital, 
labor and enterprise. The efficiency of the pro- 
ductive process depends first of all upon the abun- 
dance and character of these factors. If the}'- are 
plentiful and of good quality, the first condition of 



82 THEORY OF ECONOMICS 

effective production is met; if they are scarce or of 
poor quality, the process of production suffers 
accordingly. Next after the supply of the factors 
of production, the way in which productive forces 
are organized, conditions the efficiency of the proc- 
ess. Just as in war, the effectiveness of an army 
depends to a large extent upon its organization, so 
in the process of producing a supply of commodities 
for the satisfaction of wants, there must be a 
thorough organization for the highest efficiency. 
Furthermore, the economic process is not a sponta- 
neous affair, in the sense that it must operate and 
that, too, efficiently regardless of human choice. A 
large and excellent supply of the factors of produc- 
tion and a thorough organization can accomplish 
little or nothing without an incentive that shall 
lead to the starting of the process and inspire its 
continuance until its purpose is accomplished. 
Factors and organization without an incentive 
resemble a machine without motive power. How- 
ever excellent the material in the machine and 
however perfect the adaptation and adjustment of 
its parts, it can accomplish nothing without motive 
power. 

41. The second phase of the process of produc- 
tion is concerned with demand. The production of 
demand is dependent in many respects upon the 
supply of commodities, hence the conditions of 
eflficiency in the production of a supply affect also 
the efi&ciency of the development of demand. There 
are, however, certain other conditions which require 



PRODUCTION 83 

con£,ideration in this connection in order to under- 
stand this phase of the productive process. 

In general it may be said that the development 
of demand depends upon (1) the growth of pop- 
ulation, (2) the development of wants and (3) 
the specialization of wants. For wants to exist at 
all there must be people, human beings, who con- 
stitute at the same time the want-storehouse and 
the want-generator. Man sustains three relations 
to the economic process. First and most important 
of all, he is the end for which the process exists 
and operates. It is because of him that the eco- 
nomic process is important. To him as the highest, 
and so far as may be known, the ultimate end of 
creation, all else is subordinate. When viewed 
from this standpoint, man is not merely an economic 
phenomenon, he is a social being, endowed with 
attributes which, in the general judgment of man- 
kind in all ages, pertain not merely to the short 
span of human life, but possess an eternal signifi- 
cance. But this relation of man to the economic 
process as its raison d'etre, though of supreme 
importance, is not his only relation to the process. 
He is not only an end; he is also part of the means 
to the attainment of that end. 

In the capacity of a means to the attainment of 
the end of the economic process, man, on the one 
hand, embodies two of the factors of production, 
labor and enterprise, and on the other, he embodies 
the wants whose existence and development are at 
once the immediate end of human activity and a 



84 THEORY OF ECONOMICS 

means for further development. These relations of 
man to the economic process are by no means inde- 
pendent of each other. The consequences of man's 
status as a means to the attainment of the end of 
the economic process affect so vitally his status as 
that end, that the one can never safely be disre- 
garded in considering the other. Nevertheless, it 
is essential in seeking the general truths of eco- 
nomic activity, that these relations should be clearly 
distinguished. Bearing in mind, then, that the 
question here raised is as to the conditions of an 
efficient demand, it is evident that the first requisite 
is population. 

It was stated at the outset that the exist- 
ence of wants as an essential characteristic of hu- 
man nature is one of the fundamental hypotheses 
of economics. Some wants exist and are active in 
creating a demand so long as life itself exists. But 
not all wants exist necessarily with the existence of 
life. At least, it does not follow that because there 
is life, all wants exist in an active state. It may 
be that the germs of all wants which characterize 
the most advanced development, exist in the lowest 
stage of life, or it may be that there is actually the 
growth of new wants as man progresses. So far 
as the science of economics is concerned, it matters 
not which of these theories is accepted, for in any 
event many human wants are not active in the 
lowest stage of development, but appear little by 
little as the wants which are active in any stage, 



PRODUCTION , 85 

are met. Hence, whatever makes for the develop- 
ment of wants, affects the efficiency of demand. 

Demand as an economic phenomenon requires 
the specialization of wants, that is to say, economic 
demand does not exist simply, because general 
wants exist; the existence of economic demand re- 
quires that the general wants shall become special- 
ized by being concentrated upon specific commodi- 
ties. Thus, for example, the economic demand for 
wheat implies the existence of a general want for 
food and the concentration of that want upon 
wheat. The mere indefinite longing for something 
in general does not constitute economic demand. 
If there is a want that results in want-attracting 
power, it is because the general want has become 
centralized upon something in particular. The 
efficiency, then, of the production of wealth through 
the development of demand, depends not only upon 
the development of general wants but also upon 
their specialization . 



THE FACTORS OF PRODUCTION 



42. The factors of production are situation, capi- 
tal, labor and enterprise. Of these, the first, situa- 
tion, supplies a place for activity. Its necessity to 
the production of wealth is evident. Not all pro- 
ductive processes require the same amount of space. 
Some, such as the raising of wheat and the grow- 
ing of forests, require a large area ; others, such as 
the manufacture of shoes and the storing of com- 
modities, require less ; while still others may re- 
Walker, Political Economy, ?? 47-98, 106-109, 303, 304; 
El)% Outlines of Economics , Bk. II., Pt. I., chapters ii., iii.; 
Mill, Principles of Political Economy, Bk. I., chapters 
i.-vii., X., xi.; Marshall, Principles of Economics, Bk. II,, 
chap, iv., Bk. IV., chapters ii., iv.-vii., xii. (In most in- 
stances the references to Marshall's Principles of Economics 
apply also to his shorter work: Economics of Industry;) 
Gide, Political Economy, trans., Bk. II., Pt. I.; Laughlin, 
Elements of Political Economy, Bk. I.; Roscher, Political 
Economy, trans., Bk. I., chap, i.; Jevons, Theory of Polit- 
ical Economy, chapters v., vii.; Clark, Philosophy of Wealth, 
chap, ii.: Theory of Distribution, chapters ix., x. ; Bohm- 
Bawerk, Positive Theory of Capital , trans., Bks. I., II.; Pan- 
taleoni, Pure Econotnics, trans., Pt. III., chap, iii., H 1, 2; 
Sidgwick, Principles of Political Economy, Bk. I., chap. v. 



THE FACTORS OF PRODUCTION 87 

quire only standing room. Nevertheless, in one 
degree or another, situation is absolutely necessary 
to the production of a supply of commodities. 

Situation is usually thought of in connection with 
land. But "land," from one point of view, is too 
narrow to designate this factor. Productive activity 
may manifest itself on the water, beneath the sur- 
face of the earth or even conceivably in the air. 
When "land" is used to designate this factor of pro- 
duction, it is found necessary to define the term so 
as to include these possible places of activity.^ On 
the other hand, from another point of view, "land" 
includes too much. Associated with that term are 
soil, wood and other natural resources. But these 
are materials for production and as such they differ 
from situation in their contribution to production. 

43. The efiiciency of situation in the process of 
production depends upon its nearness to the con- 
sumer. The nearer a place is to the wants that are 
to be satisfied, the better it can assist in minister- 
ing to those wants. Thus the nearer a wheat-field 
is to the market, the less is the energy that must 
be expended in making the wheat available to the 
consumer. True, situation is not the only factor 
that affects the efl&ciency of the process of produc- 
tion. Other considerations may make it preferable 
to raise wheat a long distance from the consumer 
rather than utilize a situation that is nearer. The 
demand for wheat in England may under some 
circumstances be met better by using the fields of 

1 Marshall, Principles of Economics, Vol. I., p. 197. 



88 THEORY OF ECONOMICS 

Dakota than those of England. But when this is 
the case, it is not because of the distance but in 
spite of it. Some other advantage, such as superior 
fertihty of the soil or better opportunity of utilizing 
efficient machinery, or, frequently, the more impera- 
tive need of the nearer situation for other purposes, 
more than offset the disadvantage of distance. 

The efficiency of situation, however, is not a mere 
matter of physical distance. It is rather a question 
of ease of intercourse between the place of produc- 
tion and the consumer. A mountain range, though 
but a few miles in width, may interpose more 
effectual barriers to intercourse than an ocean hun- 
dreds of miles broad. Before the building of rail- 
roads and the adaptation of steam to transportation, 
Boston and Albany were further apart from an eco- 
nomic point of view than Boston and Savannah. 

Moreover, the importance of a given situation to 
the process of production will vary, other things 
being equal, with the number of people it serves 
and their standard of living, for the larger and 
more highly developed the population, the more 
numerous and extensive are the wants to whose 
satisfaction it may minister. A given acre in a 
large forest, which serves only as a hunting ground 
for a small tribe of Indians, may be comparatively 
unimportant to the process of production, while a 
few square feet in the heart of a large city, which 
serves as a distributing center for a large and highly 
civilized population, may be extremely important 
to that process. 



THE FACTORS OF PRODUCTION 89 

Situation, though fixed in location, is by no 
means constant in its eificiency as a factor of pro- 
duction. Variations in population and changes in 
the facilities for transportation and communication 
affect the usefulness of any given situation. The 
increase of population in the western part of the 
United States has materially increased the economic 
efficiency of situation in that section. Improved 
means of transportation are largely responsible for 
the ability of the Dakota wheat fields, already 
mentioned, to minister to the world's demand for 
wheat. On the other hand, the efiiciency of some 
situation has been decreased by migration of popu- 
lation and by improvements in facilities for trans- 
portation, which, while rendering new sections 
desirable and available, have rendered others com- 
paratively useless. 

44. A second requisite for production is material 
out of which wealth can be made. This, as well as 
situation, is necessary to the production of wealth. 
This fact is especially apparent in the case of the 
production of such forms of wealth as food, cloth- 
ing, fuel and buildings, — commodities so tangible 
that their material character is at once recognized. 
But material is equally indispensable in the case of 
other and less tangible commodities. Even the 
song and the spoken thought are but air waves 
which convey impressions to the ear of the listener.^ 

The service rendered by material to the produc- 

^ J. B. Clark, Philosophy of Wealth, p. 5. 



90 THEORY OF ECONOMICS 

tion of wealth appears in many different forms, for 
the nature of the wants seeking satisfaction are 
numerous and varied. As land, material supplies a 
foundation upon which men live and carry on their 
activities and a storehouse within which are con- 
tained metals, oil, coal and other useful commodi- 
ties. As soil, also, it supplies conditions essential 
to the maintenance and propagation of vegetable 
life. As water, it affords other conditions essential 
to life, both vegetable and animal, and, in the form 
of rivers, lakes and oceans, it facilitates intercourse 
and supplies a suitable environment for some kinds 
of animal life. In still another form, material ap- 
pears as air, which is necessary to life, and consti- 
tutes a medium for communicating light and sound. 
Material in some of its forms affords a food sup- 
ply and the so-called "raw materials," from which 
other kinds of wealth may be produced ; made into 
tools, machinery and buildings, it contributes still 
further to the satisfaction of wants. The various 
services of this factor of production are, in a gen- 
eral way, indicated by the four classes into which 
materials are sometimes divided: (1) soil, air and 
water, (2) subsistence fund, (3) raw materials, and 
(4) buildings, tools and machinery. This classifica- 
tion, though far from being scientifically precise, 
serves a useful purpose by way of description. In 
the ultimate analysis, however, the services of ma- 
terial may be reduced to one: its function is to 
provide the means for embodying want-attracting 
power. 



THE FACTORS OF PRODUCTION 91 

From the standpoint of economic science, mate- 
rials constitute the capital fund of society. This 
use of the term "capital" should be carefully dis- 
tinguished from others in popular phrase, where it 
is employed with a variety of meanings, not wholly 
different perhaps, but lacking scientific precision. 
Thus "capital" is sometimes used in speaking of a 
bank or business enterprise, to denote the original 
investment, actual or nominal, or the value of the 
plant. The term is also used to designate the prop- 
perty or assets of an individual or firm, or even as 
synonymous with an amount loaned for which inter- 
est is received. Social capital consists of the mate- 
rials, in whatever form they may exist, that are 
available for aiding in the production of wealth. 

45. The efficiency of capital in the process of 
production depends first of all upon the physical 
excellence of materials and their abundance. The 
more nourishing the food, the more fertile the soil, 
the more durable the buildings, tools, and machin- 
ery, and the better the quality of the raw materials, 
the greater is the efiiciency of these several forms 
of capital in the economic process. 

The efiiciency of capital varies to some extent 
also according as it is applied to the immediate 
satisfaction of so-called final desires or is utilized 
to promote the process of production in other ways. 
Thus, wood may be consumed as fuel to supply 
warmth, or it may serve to generate steam in an 
engine ; it may be used in the erection of a dwell- 
ing for immediate comfort and pleasure, or to 



92 THEORY OF ECONOMICS 

build a factory, which will facilitate the produc- 
tion of that which will minister to final desires. 

In the primitive conditions of society, material 
aids to production consisted chiefly of the soil and 
of such things as nature offers spontaneously to 
man, — the forest, game, fish, fruit, etc. But man 
soon learned to adapt the material at his disposal 
to promote the satisfaction of wants in other ways 
than by its consumption in the satisfaction of final 
desires, and there followed the process of saving 
and capital-building. The result has been such a 
vast increase in productive efiiciency that more 
and more the energy of society is expended in 
this way. To-day a large portion of the wealth 
of society consists of that which is directly in- 
tended to aid in future production. This char- 
acteristic of modern society affords one of the most 
striking contrasts with the conditions of primitive 
times. 

There is, it is true, a limit to the profitable appli- 
cation of energy to production in other ways than 
by the satisfaction of final desires. The store of 
human energy is maintained by present gratifica- 
tions of wants, and provision for future production 
which disregards the necessity of providing the 
requisite human energy through satisfying present 
wants, would so far reduce the store of productive 
energy as to impair the entire process. However, 
the pressure of wants demanding immediate satis- 
faction may in general be relied upon to prevent 
such results. The productive process is far more 



THE FACTORS OF PRODUCTION 93 

liable to injur}' from too little than from too much 
saving. 

The efficiency of the process of production is 
influenced also by the relative amounts of circulat- 
ing and fixed capital. Economic capital is called 
circulating or fixed according as, in the words of 
Mill, it "fulfills the whole of its oSice in the pro- 
duction in which it is engaged, by a single use," or 
exists in a durable shape, "the return to which is 
spread over a corresponding duration."^ This dis- 
tinction indicates relative rather than absolute 
conditions, but it is not the less important. Cir- 
culating capital appears in the shape of food, fertil- 
izers, raw materials and finished products for 
immediate consumption; fixed capital consists of 
soil, buildings, tools and machinery. The greater 
durability of fixed capital enables it to serve 
the productive process for a longer period than 
can circulating capital. This is in man 5^ re- 
spects an advantage, but it is not to be in- 
ferred that economic efi&ciency is to be promoted 
by turning all the material possible into 
fixed capital. Circulating capital is equally 
important to the economic process. While its 
service is not so long continued, it cannot be dis- 
pensed with. Without it, fixed capital would be 
useless. Moreover, circulating capital has an ad- 
vantage as compared with fixed capital in the 
adaptability of the former to various uses, so that 
there is less loss to society when changes occur in 

'^ Political Economy, Bk. I., chap, vi., § 1. 



94 THEORY OF ECOISrOMICS 

wants, which often tend to render fixed capital 
comparatively useless. 

A definite quantitative statement of the most 
eflficient proportionate distribution of material be- 
tween these two classes of capital cannot be given. 
It doubtless varies from time to time. But it is 
desirable to recognize that disproportionate devel- 
opment of either will impair the productive process. 

46. A third requisite for production is found in 
man's ability to work. This ability in its active state 
is called labor, and the term "labor" or "labor- 
power" may be used to designate this factor of 
production both in its active and in its passive 
state, though it is seldom necessary to employ it in 
the latter sense. Analyzed, this factor of produc- 
tion is seen to consist of physical strength and of 
intelligence. Both of these qualities are necessary 
to labor, whether in its simplest forms, such as is 
employed in digging a ditch and in pounding rocks, 
or in its higher forms, such as appear in the con- 
struction of delicate machinery and in the perform- 
ance of surgical operations. 

But though physical strength and intelligence 
are essential to all labor, these fundamental ele- 
ments contribute in different degrees to different 
kinds of labor. This fact is made the basis of a 
classification of labor as physical and mental accord- 
ing as physical strength or intelligence seems to be 
most important in any given manifestation of labor. 
Still another distinction is occasionally made be- 
tween labor and service, the term labor being 



THE FACTORS OF PRODUCTION 95 

limited to those forms of human activity that are 
expended upon tangible things and give tangible 
results, while to other forms the term service is ap- 
plied. These classifications of labor, like those of 
capital, though perhaps useful for descriptive pur- 
poses, are not scientific. There is no definite 
dividing line between ph5'sical and mental labor 
nor between labor and service. Both "labor" 
and service are labor, and all labor is physical and 
mental. 

47. The efficiency of labor-power in the produc- 
tive process depends upon the conditions requisite 
for the development and maintenance of strength 
and intelligence. The most important of these 
conditions are heredity, nourishment, including en- 
vironment, and training. 

The extent of the influence of heredity upon 
labor involves the question as to how far the char- 
acteristics of a parent are transmitted to its off- 
spring. Scholars whose special province it is to 
investigate this problem, are not entirely agreed in 
their conclusions. The weight of opinion, how- 
ever, favors the theory that both physical and men- 
tal characteristics are transmitted by heredity. 
This conclusion, if correct, has a very important 
bearing upon the efficiency of the productive capac- 
ity of society, through the extent to which the 
efficiency of any generation may be conditioned by 
its ancestors, its productive capacity being either 
maintained and increased as, in the perpetuation of 
the species, health and strength prevail, or impaired 



96 THEORY OF ECONOMICS 

and perhaps destro5'ed as disease and weakness 
predominate. 

Of the conditions determining the efficienc)' of 
labor, the influence of nourishment is perhaps most 
immediately perceptible. Of prime importance in 
this connection is the character and abundance of 
the supply of food materials. Upon these, exist- 
ence itself depends. But the labor efficiency which 
rests upon a food supply sufficient only for bare 
existence is of an extremely low grade. Up to a 
certain point, there is a distinct economic gain to 
society in bettering the food supply of the laborers, 
for it results in a more than proportional increase 
of labor-power.^ Moreover, it is not simply the 
character and abundance of the food in its raw 
state that conditions the efficiency of labor. The 
preparation of food for consumption is also impor- 
tant. Until a comparatively recent date, little, if 
any, effort was made to secure information as to 
the relative efficiency of different foods and the best 
method of preparing them for consumption. And 
even now little heed is given in practice to the con- 
tributions of science to this subject. 

Closely akin to food supply is shelter, including 
housing, clothing and fuel, all of which are impor- 
tant factors in conserving the energy of labor. 
With these, ma}^ be mentioned also climatic and 
sanitary conditions. If the climate be too cold or 
too warm, too moist or too dr}^ the result will be 

1 Walker, Political Economy, p. 47. 



THE FACTORS OF PRODUCTION 97 

detrimental to labor-power. These conditions are, 
however, largely beyond the control of man, except 
as he may be able to leave unhealthy regions and 
seek localities more favorable to activity. But in 
so far as labor is affected by sanitary conditions, 
the situation is often of man's own making. The 
vitiating influence of sweat-shops, congested popu- 
lation, poor drainage, filthy streets and similar evils 
which sap the vitality of man, lies within the 
power of society to correct. The removal of such 
abuses is called for, not merely on general human- 
itarian grounds, but also in order that the present 
and the future labor-power of society may not 
suffer serious impairment. 

In addition to heredity and nourishment, 
training is important to the efficiency of labor. 
Training tends to elevate labor above mere brute 
force and by the knowledge of how to do, adds to 
the efiiciency of the strength to do. By practice 
and intelligent instruction, labor becomes habitu- 
ated to certain modes of activity, thereby facilitat- 
ing their performance and releasing energy for 
other activity. Unskilled labor requires superin- 
tendence, is wasteful of material and time, and is 
often incapable of handling the complicated and 
delicate machinery which contributes so largely to 
the productivity of modern industry. So essential 
is skilled labor to efficient industry that society has 
generally considered it profitable to take special 
steps to promote the training of laborers. Formerly 
through apprenticeship laws, a certain time of 



98 THEORY OF ECONOMICS 

preparation and the making of a master-piece were 
required as conditions for entering many occupa- 
tions. Modern conditions have led in large meas- 
ure to the abandonment of the old apprenticeship 
system, and it was thought for a while that ma- 
chinery would lessen the need for skilled labor. 
But the converse has proven true and the end 
formerly sought by apprenticeship laws is now 
being realized by the aid of technical schools. 

The conditions of efficiency mentioned, affect 
both the physical strength and the intelligence, the 
fundamental elements of labor-power. To intelli- 
gence as well as to physical strength, a generous 
endowment of native capacity, proper nourishment 
and training are essential. To some extent these 
conditions must be specially adjusted to each of 
these elements, but the fact of the interdependence 
of man's physical and intellectual nature, render's 
it probable that whatever promotes the effectiveness 
of one will redound to the good of the other. 

48. The fourth factor of production is enterprise. 
It consists in the capacity to put into operation in- 
dustrial undertakings. It must not be confused 
with the so-called labor of superintendence, though 
this form of activity involves enterprise, as indeed 
do all others in so far as they necessitate inde- 
pendent initiative. In the simplest forms of activ- 
ity, comparatively little enterprise is needed. To 
appropriate food which lies ready at hand, requires 
but little effort, and no one in a normal condition 
is so wanting in enterprise as to be unable to do this 



THE FACTORS OF PRODUCTION 99 

much for the satisfaction of his wants. Compara- 
tively speaking, the enterprise required to dig a 
ditch, to hunt or to fish is as a rule slight. Conse- 
quently so long as industrial undertakings were on 
a small scale, this requisite for production did not 
assume any marked importance. Indeed, its exist- 
ence as a distinct factor of production was long 
unrecognized. 

To-day all this is changed. With the develop- 
ment of modern conditions, involving large under- 
takings, this factor appears both as distinct in kind, 
because performing a distinct function, and as of 
prime importance to the economic process. In 
common phrase it is often referred to as "business 
ability", and it is readily seen that the ability to 
establish and operate an extensive railroad system 
or a manufacturing industry which seeks a world- 
wide patronage and depends for success upon the 
accurate estimate of wants in widely separate locali- 
ties, is of a vastly higher order than the ability 
necessary to run a local dray or to produce vege- 
tables for one's self or for a local market. Differ- 
ences in economic status to-day result not so much 
from differences in opportunities as from differences 
in the ability to improve opportunity. The great 
success attained by the leaders of industry is due 
primarily to their possession of a high grade of 
enterprise. 

49. The determination of the conditions upon 
which the grade of enterprise and, as a conse- 
quence, its efficiency in contributing to the eco- 

L.ofC. 



100 THEORY OF ECONOMICS 

nomic process, depends, requires first an analysis 
of man's nature to discover what elements therein 
constitute the basis of this factor of production. 
Such an analysis shows that the essential element 
of enterprise is will power. To possess will power 
is to possess the requisite energy for action. That 
which develops the will power gives enterprise. 
But the will as a characteristic of human nature is 
dependent upon those conditions that determine hu- 
man nature, — heredity, nourishment and training, 
already discussed in connection with labor. In the 
case of labor, these conditions determine physical 
strength and intelligence; in the case of enterprise, 
they determine will power. 

But economically effective enterprise requires 
more than mere strength of will ; the moral char- 
acter is also of great importance. In the economic 
process many wants press for satisfaction and it be- 
comes necessary to choose at any given time some one 
want to which attention shall be given. Moreover, 
there is a difference in the effect of the satisfaction 
of different wants upon economic efficiency. In the 
case of some wants, such as the want for alcoholic 
or other stimulants, satisfaction may work injury 
to future activity. If their satisfaction undermines 
the physical strength, impairs the intelligence or 
weakens the will, the efficiency of labor and enter- 
prise will suffer. And even when the satisfaction 
of a want is not positively detrimental, if it stands 
in the way of the satisfaction of a want more con- 
ducive to the general good, the result is an impair- 



THE FACTORS OF PRODUCTION 101 

ment of economic eflSciency. Thus the preference 
of present gratification to future gain may mean a 
less effective appHcation of energy. Furthermore, 
the satisfaction of some wants may be injurious 
because inconsistent with the rights of fellow mem- 
bers of society. The right to private property, for 
example, is economically beneficial because it frees 
for other purposes energy that, in the absence of 
such a right, would be required for the defense of 
one's possessions. Hence to disregard this right 
and to steal detracts from economic efficiency. 

Much, then, of the efficiency of enterprise will 
depend upon the ability, in the presence of the 
requisite knowledge and physical strength, to select 
from two or more possible lines of action, that 
which is most conducive to welfare. Herein lies 
the important relation of the moral character of an 
individual to the economic process. If a man has 
the necessary labor-power, the extent to which he 
tries to do honest work will materially affect his 
economic efficiency. And the extent to which he 
seeks to do honest work depends directly upon the 
moral quality of his will power, the basis of his 
enterprise. The moral element of enterprise, there- 
fore, has an immediate and positive bearing upon 
economic efficiency. 

50. The four factors of production, situation, 
capital, labor and enterprise, may be called req- 
uisites for production, since their cooperation is 
absolutely necessary to the production of wealth. 
This fact needs to be emphasized because in the 



102 THEORY OF ECONOMICS 

looseness of much current economic theory the in- 
ference is warranted, if the express statement is not 
made, that though these factors sometimes, perhaps 
usually, cooperate in the production of wealth, still 
wealth may be produced by the factors acting inde- 
pendently of each other or at least by the coopera- 
tion of two or three of them.^ Such a view rests 
upon an incomplete or an inaccurate analysis of the 
process of production, or it results from the disre- 
gard of the service of one or more of the factors 
in some instances because of its apparent insig- 
nificance. It is true that under certain cir- 
cumstances, the service of a factor in the 
production of wealth may for practical purposes be 
overlooked, but for scientific purposes, such serv- 
ice may be ignored only when it is entirelj^ absent. 
In many industrial operations, the cooperation 
of all the factors is apparent. For example, in the 
manufacture of cloth, the presence of each factor 
maj^ readily be recognized throughout the entire 
operation from the growing of the fiber to the 
weaving of the cloth. But the four factors are as 
truly necessar}^ for the production of other forms 
of wealth. Take, for example, the forest tree. 
The only requisite for its production might seem to 
be situation and soil. But the tree is not wealth 
until it possesses want-attracting power. It can 
possess want-attracting power only when it is 
known to exist, and even though the finding of the 
tree be accidental, it involves both labor and enter- 

^ Walker, Political Economy, ?121. 



THE FACTORS OF PRODUCTION 103 

prise. Again, there are portions of wealth which 
may seem to result entirely from labor. Indeed, 
one class of social reformers, the socialists, base 
their justification of the proposition to overthrow 
the existing order of industrial organization upon 
the claim that all wealth is the result of labor. ^ 
That labor is essential to the production of all 
wealth, is undoubtedly true, but a closer look at the 
process of producing the wealth which is ascribed 
solely to labor, will' show in every instance that 
labor has had the cooperation of the other factors. 
The presence of situation will readily be recognized. 
Capital also will be found in the form of food prod- 
ucts and otherwise. Nor is the objection valid that 
food which is for consumption should not be in- 
cluded in capital. The frequent designation of 
food as capital only until it comes into the posses- 
sion of a consumer, involves an arbitrary distinction 
wholly wanting in logical consistency. Material 
used to fertilize the soil, it is said, is capital, while 
material used to nourish the body and maintain its 
strength is not capital. Such statements are man- 
ifestly inconsistent. The erroneous theory that 
labor, unaided by the other factors, can produce 
wealth, results in an exaggerated idea of the impor- 
tance of labor in production. If the theory of the 
socialists were correct, it would follow that the 
entrepreneur is a social parasite, and yet labor 
without enterprise is but potential productive 
energy. 

^ Schaffle, Quintessence of Socialism, p. 26. 



104 THEORY OF ECONOMICS 

Though an analysis of the productive process 
reveals the necessity of the four factors to the 
production of wealth, it does not follow that these 
factors necessarily find manifestation in separate 
and distinct physical forms. There is never labor 
in action without enterprise, nor, on the other 
hand, is enterprise ever active without involving 
labor. 



THE ECONOMIC ORGANIZATION 



51. The efficiency of production has been greatly 
increased by the systematic cooperation of indus- 
trial agents. Two men with a team and wagon can 
accomplish more than twice as much in a given 
time drawing hay, as can one man working alone 
with a horse and wagon. Ten men engaged in 
making boxes will produce more if they cooperate 
systematically than if each man works by himself. 
The process of securing the satisfaction of wants is 
less efficient in a community where each family 
ministers to its own wants entirely than in one 
where the members cooperate. In general, it may 
be affirmed as a vahd principle, that the output of 
a given number of productive units cooperating will 
exceed that of the same number working independ- 
ently. 

Walker, Political Economy, §g 80-85, 408; Ely, Outlines 
of Econoinics, Bk. II., Pt. I., chapter iii. ; Gide, Political 
Economy, trans., Bk. II. Pt. II., chapters i., ii.; Marshall, 
Principles of Economics, Bk. IV., chapters viii.-xii. ; Laugh- 
lin, Elements of Political Economy, chapter vi. ; Mill, 
Principles of Political Economy, Bk. I., chapters viii. , ix. ; 
Roscher, Political Economy, trans., Bk. I., chapter ii. 

105 



106 THEORY OF ECONOMICS 

This systematic cooperation for securing the 
satisfaction of wants is the economic organization. 
In many of its forms it is readily recognized. The 
making of wagons, the weaving of cloth, the 
sailing of ships, the mining of coal, and, in- 
deed, most industries, require the cooperation of 
several for their successful operation. The extent 
to which cooperation is applied depends in part, it 
is true, upon the character of the industry, for not 
all industries are equally suited to the application 
of this condition of economic efl&cienc}^ Thus 
organization of industry in farming is not carried 
to the same extent as in a factory. But though 
appearing in different forms and in varying degrees 
in different industries, the cooperation of the social 
units for the satisfaction of wants is so general as 
to be commonly recognized as a distinguishing- 
feature of modern business. 

The \dew of economic organization, however, 
which sees it only in individual enterprises, falls 
far short of comprehending the full scope of this 
feature of the economic process, for the economic 
organization embraces all efforts for the satisfaction 
of wants to which more than one individual con- 
tributes. The tea grower in Ceylon, the cotton 
planter in Texas, and the manufacturer of cutlery 
in England are members of the same economic 
organization in so far as their efforts contribute to 
the mutual satisfaction of wants, just as truly as 
are the manager, engineer, weaver and shipper in a 
cotton factory. Indeed, the economic organization 



THE ECONOMIC ORGANIZATION 107 

is a complex and far-reaching affair, a fact that any 
one may reahze for himself, if he will but consider 
the extent to which others, some known to him 
and some unknown, have shared in producing that 
which he consumes. His clothing, fuel, house, 
tools, and in fact nearly all or quite all that minis- 
ters to him, represent the activity of others as well 
as of himself. The economic organization of society 
is coextensive with cooperating human activity. 

The beginnings of this organization are as old 
as society itself. As has been said, the essen- 
tial characteristic of society is relationship, and 
wherever relationships exist, there will be found 
cooperation for want-satisfaction. In primitive times 
this cooperation was doubtless very limited. It 
may have included but few human beings, perhaps 
only the members of a family. They may have 
cooperated only for the perpetuation of the species 
and for common defense. But they cooperated, and 
from their simple beginnings, in the course of time, 
has developed an ever increasing association, until 
to-day the economic organization is practically 
world-wide. And the importance of this world- 
wide organization of activity is evidenced by the 
fact that no nation could to-day be shut off from 
intercourse with other nations without serious im- 
pairment of the power of its citizens to satisfy their 
wants. 

52. The economic organization presents two dis- 
tinctive features: division of function and unifica- 
tion of design. Through the extension of the 



108 THEORY OF ECONOMICS 

scope and efficiency of these, the development of 
the organization has been reaUzed, 

The first and most apparent feature of the eco- 
nomic organization is division of function. This 
consists in the distribution of the parts of a process 
among more or less distinct agencies. Thus in 
making boxes one man may cut the boards into 
proper lengths, and another may put them together. 
In harvesting wheat, one man may cut the grain, 
another may bind it, while a third may gather the 
bundles, and perhaps a fourth and fifth may attend 
to hauhng them to the thresher. Indeed, if the 
illustration were extended to include all who share 
in preparing the grain for consumption as food, 
there would be added to those mentioned, the miller 
and the baker, the machinist, the carrier, and those 
engaged in mining and lumber industries who have 
aided in providing the machinery, besides numerous 
others. Many of these operations, in turn, present 
in themselves an application of division of function 
upon an extensive scale. One may start with the 
simplest of modem industrial processes and find in- 
volved therein, directly or indirectly, a large amount 
of division of function. 

The beginnings of division of function histori- 
cally are lost in the uncertainties surrounding the 
beginnings of society. But as from the first men 
have utilized the principle of cooperation in seek- 
ing the satisfaction of their wants, it is evident 
that division of function is as old as society itself. 
The early steps in dividing the economic process 



THE ECONOMIC ORGANIZATION 109 

among the members of society were doubtless very 
simple. They probably did not extend further than 
the division among them of different occupations. 
Some hunted, others fished, while others may have 
made the implements necessary for the chase or for 
fishing. This elementary form of division of func- 
tion has sometimes been called ' 'division of occupa- 
tion" to distinguish it from the more extended 
application, which is called "division of labor," the 
former consisting in the differentiation of the 
economic process into such relatively complete 
operations as are represented by the occupations of 
the carpenter, the farmer, the blacksmith, and the 
weaver, while the latter consists in the further 
differentiation of such occupations. Though this 
distinction may be useful in calling attention to 
differences in the extent to which division of func- 
tion is applied, as a matter of fact both "division 
of occupation" and "division of labor" are one in 
principle. 

However crude the early manifestations of divis- 
ion of function may have been, its application to- 
day, both in number of persons essential to an 
operation and in minuteness of subdivision of the 
processes, has reached a development difficult to 
appreciate, unless one is in immediate touch with 
modern business organization. The following are 
given as "distinct branches of shoemaking at which 
men, women, and children are kept constantly at 
work in the most perfect of the modern shoe fac- 
tories;" "binders, blockers, bootliners, beaters-out. 



110 THEORY OF ECONOMICS 

boot-turners, bottomers, buffers, burnishers, chan- 
nelers, counter-makers, crimpers, cutters, dressers, 
edge-setters, eyeleters, finishers, fitters, heelers, 
lasters, levelers, machine-peggers, McKay-stitchers, 
nailers, packers, parters, peggers, pressers, rosette- 
makers, siders, sand-paperers, skinners, stitchers, 
stringers, treers, trimmers, welters, button-hole 
makers, clampers, deckers, closers, corders, em- 
bossers, gluers, inner-sole makers, lacers, leather 
. assorters, riveters, rollers, seam-rubbers, shank- 
pressers, shavers, slipper-liners, sole-leather cut- 
ters, sole-quilters, stampers, stiffeners, stock-fitters, 
strippers, taggers, tip-makers, turners and vamp- 
ers."^ Even the cobbler of a few decades ago 
would not recognize some of these operations. And 
this list does not include all the forms of activity 
essential to a modern shoe factory, much less does 
it include all those which contribute to the prepara- 
tion of shoes for the consumer. 

53. Though division of function may be the most 
apparent feature of the economic organization, it is 
not more important than its complement, unification 
of design. This consists in the working of the 
various parts of the process towards a common end. 
It is not more important that the various functions 
of an organism should be distributed among special 
organs, than that those organs should so work to- 
gether as to promote a common end, the welfare of 
the organism. So, in the economic organization, 

1 David A. Wells, Recent Economic Changes, p. 94, note. 



THE ECONOMIC ORGANIZATION 111 

for the efficiency of division of function, it is abso- 
lutely necessary that the amount and kind of serv- 
ice performed by each agent should be such as to 
harmonize with the activities of the others in pro- 
moting the common end, the satisfaction of wants. 
It is not sufficient that one produce food and another 
clothing. The satisfaction of wants will be re- 
tarded rather than promoted as a result- of such 
division of function, unless each adjust his actions 
to the wants of both. 

The question as to how the unification of design 
can best be attained, whether and to what extent 
by leaving to each individual the initiative and con- 
trol of his activity or by giving that initiative and 
control to society, collectively, is one of the most 
serious of social problems. The first requisite for 
solving this problem is an adequate appreciation of 
the extent to which economic efficiency depends 
upon unification of design, a fact which calls for 
the more emphasis because of the degree to which 
it escapes notice. 

In individual undertakings and within limited 
areas, one can see the importance of working with 
his fellows to a common plan. If, in making boxes, 
he who saws the lumber disregards the require- 
ments as to length, or saws too many of one length 
when others are needed to keep his fellow workmen 
occupied, it is readily seen that the operation will 
suffer. So, also, as regards those who work to- 
gether in a factory, there is little difficulty in realiz- 
ing the necessity of harmonious cooperation in their 



112 THEORY OF ECONOMICS 

work. But in the far-reaching and complex rela- 
tions of modern industrial activity, the specific 
bearing of one man's acts and their ultimate conse- 
quences are often quite beyond his powers of com- 
prehension. The cattle herder on a South American 
ranch can have no adequate conception of the rela- 
tion of his activity to the wants of those who will 
ultimately consume the beef and leather from the 
cattle he is tending. Indeed, the relation in any 
single instance may be of comparatively slight im- 
portance. Still, no act that in any way affects the 
common end of satisfying wants, can be said to be 
wholly without importance. And upon harmony 
of activity depends in large measure the efl&ciency 
of the economic process. 

54. While economic activity is deliberate in the 
sense that it is the result of the conscious effort of 
man to satisfy his wants, the organization of that 
activity lies in large measure beyond the immediate 
purpose of which the individual is conscious in 
seeking the satisfaction of his wants. To some 
extent, it is true, industry is organized as the result 
of deliberate intent; that is to say, there are many 
instances in which the individual sees the necessity 
of systematic cooperation and seeks to secure it. 
In harvesting crops, in establishing a cotton factory 
or a railroad, the individual proceeds to solicit the 
assistance of others, and deliberately organizes the 
activity. But of the sum total of organized activity, 
of which an individual industry is a part, much lies 
quite beyond the conscious purpose of the indi- 



THE ECONOMIC ORGANIZATION 113 

viduals concerned. It results unconsciously from 
the way in which individuals seek their own good. 

Division of function in economic organization 
results from the tendency of energy to seek the 
path of least resistance. It is because the satisfac- 
tion of wants can be attained with less effort when 
the process is subdivided, that division of function 
exists and develops. This tendency leads to the 
selection of the new and more efficient and to the 
rejection of the old and less efficient, and to the 
increase of the fitness of that which survives, a 
process already described as accomplished through 
the complementary working of competition and 
monopolization . 

To unification of design, which is the comple- 
ment of division of function, two conditions are 
essential. First, an individual must be able to con- 
template as a good for himself that which, with or 
without his knowledge, involves a good to others. 
In the second place, so many as are necessary to 
the performance of that which involves a common 
good, must see the possibility of good to themselves 
in the same direction, i. e., in action which har- 
monizes. Two men meeting on the highway illus- 
trate these conditions, when each turns out to the 
right in order that he may pass the other. To this 
end it is necessary that each should be capable of 
seeing a possible benefit to himself by turning to 
one side, an act which involves a benefit to both. 
In addition to this, both must see the possibility of 
benefit in the same way, /. <?. , by turning to the 



114 THEORY OF ECONOMICS 

right or to the left. Otherwise, though recogniz- 
ing the desirabihty of turning out, they will collide. 
Simple as this act may be, it involves all the ele- 
ments that are the basis of unification of design 
throughout society. In the case supposed, the 
common nature of the good may be apparent to 
those concerned, though it may never enter their 
thoughts as such ; while in other instances, where 
the parties are widely separated, each may contem- 
plate only his owai good. But whether harmony of 
action is conscious or unconscious, it is due to the 
fact that men possess by nature the capacity to con- 
ceive of a common good and to act for that good.^ 

55. Three important advantages result from the 
economic organization : (1) it makes possible cer- 
tain undertakings; (2) it promotes the development 
of productive agencies of a higher grade of efficiency; 
and (3) it facilitates the more economical application 
of energy by existing agencies. 

The organization of activity brings within the 
range of possibility some undertakings that would 
otherwise be impossible of accomplishment, for many 
things are beyond the power of an individual work- 
ing alone, because their performance requires the 
immediate application of more energy than he pos- 
sesses. This advantage becomes especially signifi- 
cant in the presence of the stupendous under- 

^ Cf. Thomas Hill Green, Lectures on the Principles of Po- 
litical Obligation, reprinted from his Philosophical Works, 
vol. ii., p. 121 et seq. 



THE ECONOMIC ORGANIZATION 115 

takings of modern business, in transportation, min- 
ing and elsewhere. Success in such enterprises as 
the Suez or Nicaragua canals, the Trans-Siberian 
and Trans- Continental railroads, the Niagara Falls 
power plant, and other similar industries, is im- 
possible without systematic cooperation, if for no 
other reason than because they are too large for 
one man. 

But this benefit from organization is not limited 
to operations of such size. If in the transfer of a 
pile of stones from one place to another, some are 
found that are too heavy for one man to lift, the 
performance of the task becomes possible only by 
the cooperation of others. Moreover, the coopera- 
tion even in so slight a matter must be systematic. 
The efforts must be applied simultaneously and in 
the requisite direction. Few, indeed, are the in- 
dustries that are to-day unaffected by this advan- 
tage of organization. 

56. Again, organization promotes the develop- 
ment of a higher grade of productive agencies. 
This appears especially in connection with skill and 
the invention of labor-saving devices. The mere 
fact that a man limits the range of his activities 
and concentrates his attention upon a few opera- 
tions tends to sharpen his faculties and to increase 
his skill within the narrower field. A man makes 
a better blacksmith when he is not obliged to divide 
his attention between blacksmithing and farming, 
carpentering and other vocations. The sculptor 
attains a higher grade of skill in his profession 



116 THEORY OF ECONOMICS 

when not compelled to combine with it the various 
other forms of activity that are essential to the 
satisfaction of his wants. 

Furthermore, the limitation of the field of activity 
quickens the inventive genius of man and results 
in the introduction of better tools and machinery 
and in the discovery of new possibilities in the 
material at his disposal. One of the distinguishing 
features of the present system of manufactures is 
the extent to which labor-saving machinery is 
employed. The modern printing press, for exam- 
ple, is a marvel of human ingenuity. Instead of 
the old hand machine, there is now a power press 
into which blank paper is fed and out of which 
there comes a complete newspaper, printed, cut, 
pasted and folded, ready for delivery. Years ago 
the making of pins was a laborious process. By 
the close of the eighteenth century, ten men could 
make 48,000 pins in a day, and this was considered 
a wonderful triumph of improved machinery. Now 
three men with the aid of machinery can produce 
7,500,000 pins in a day.^ Many mechanical devices 
now in common use seem almost human in the 
complexity of their operations and more than hu- 
man in the perfection of their results. 

57. Organization not only leads to the development 
of better agencies for production, but it also makes 
possible a more economical application of existing 

1 David A. Wells, Recent Economic Changes^ p. 69. Read 
Chapter 2. 



THE ECONOMIC ORGANIZATION 117 

agencies. This advantage appears, in one form, in a 
more extensive utilization of special facilities. Thus, 
one may have a special aptitude for mechanics, an- 
other for farming, another for art and another for 
planning and controlling industries. Organization 
enables society to profit by these special aptitudes 
and thereby lessens the necessity of expending energy 
on that for which one is but little fitted. A similar 
advantage accrues also in connection with commu- 
nities and nations, which differ both in natural re- 
sources and in development. Thus, one section may 
possess iron and coal, another may be especially 
suited to cotton-growing and another to the pro- 
duction of breadstuffs. Climatic and other condi- 
tions result in wide differences in facilities for pro- 
duction. Tropical vegetation is unlike that of the 
temperate zone, and both differ from that of the 
extreme north or south. Furthermore, nations 
exist in different stages of economic development. 
Some are especially suited for the production of raw 
materials, others for manufacturing those materials 
into products for final consumption. All these 
differences redound to the advantage of society 
through organization of industry, which makes 
possible the satisfaction of wants from those sources 
of supply that are best adapted thereto. 

Another form in which this advantage appears 
is in the saving of material and labor, especially in 
connection with the concentration of industries into 
large establishments, one of the most characteristic 
features of modern business. Many things that in 



118 THEORY OF ECONOMICS 

small, isolated establishments are discarded as waste, 
not only failing to add to, but actually detracting 
from, the efficiency of production, become useful 
in large industries. When the preparation of meat 
for the market was in the hands of small producers, 
the hoofs, entrails, horns and even the hair and 
bones were commonly thrown away. But with the 
modern methods of large packing establishments, 
means of utilizing this waste have been found to 
such an extent, it is said, that there is now abso- 
lutely no portion of the animal which does not con- 
tribute some useful commodity. Many other in- 
dustries, notably the refining of oil, afford similar 
evidence of the gain to society in economic efficiency 
through the saving of material. 

lyabor, too, is often saved as a result of organ- 
ization, thereby releasing energy for other opera- 
tions. Sometimes this gain appears in the shorten- 
ing of the time between the beginning and the 
completion of a commodity. More often, perhaps, 
it is effected through a decrease in the average 
time required to produce a commodity. Because 
of the number and complexity of the different 
operations, it may be that the actual time between 
the beginning and the completion of a given pair of 
boots is sometimes longer under modern methods, 
but, considering the large number of boots simul- 
taneously in course of production, when the average 
time required for making a pair is computed, there 
will be found an immense saving as compared with 
the old methods. This advantage of economic or- 



THE ECONOMIC ORGANIZATION 119 

ganization appears also in a saving in the time 
requisite for learning an occupation, i. e., in short- 
ening the term of apprenticeship. Society gains as 
a result of this, through the increase in the number 
of productive years in the lives of its members. 

The saving of labor appears also in the fact that 
the organization of industry often enables the same 
results to be obtained with fewer laborers. Thus it 
may require but little more expenditure of energy 
to superintend 100 men than 50, provided they are 
assembled in the same establishment or under the 
same control; and the result is a gain to society. 
This result of organization is seen frequently in 
connection with the consolidation of railroads, 
whereby the necessity of duplicating general oJ6&cers 
is obviated. Another illustration of a similar nature 
is found in the consolidation of different manufactur- 
ing establishments, thereby saving labor through 
the decrease in number both of superintendents and 
salesmen. 

Though the advantages of organization appear 
in various forms, they may be reduced to one. 
They consist in the more efl&cient application of 
energy to the process of want- satisfaction. Division 
of function contributes to this end by the substitu- 
tion of more for less efficient agencies. But to real- 
ize the possible advantages of these improved 
agencies, there must be harmony in their activity, 
a unification of design in their working. The serv- 
ice of this unification of design to the economic 
process may be described as consisting in the de- 



120 THEORY OF ECONOMICS 

crease of friction, whereby energy that would other- 
wise be wasted, is usefully applied. 

58. The advantages resulting from the organiza- 
tion of activity may be offset to some extent by 
certain disadvantages, for the organization is sus- 
ceptible to certain disorders which tend to lessen its 
efficiency and give rise to serious problems. The 
very fact that machinery is more complex renders 
necessary greater care that it does not get out of 
order. Loss to the process of satisfying wants is 
especially liable from two causes inseparable from 
the association of men for economic ends. In the 
first place, there is danger that the dependence 
among the productive units may become so dispro- 
portionate as to result in injury to the process, and, 
in the second place, there is a possibility that a fail- 
ure to adjust the suppl}- of commodities to the de- 
mand therefor, may lead to waste through what is 
commonly designated "overproduction." A con- 
sideration of these possible disorders will throw 
further light upon the nature of the economic organ- 
ization and its relation to the economic process. 

Division of function results in making the units 
dependent upon each other. When a man ceases 
to pursue the entire process of making cloth- 
ing, confining himself exclusively to producing 
wool or to spinning 5'arn or to weaving cloth or to 
cutting, sewing and finishing garments, he becomes 
to some extent dependent upon others for his cloth- 
ing. When a nation ceases to supply all that is 
necessary to finished products, confining itself to 



THE ECONOMIC ORGANIZATION 121 

manufacturing or to the production of raw mate- 
rials and relying upon others for that which 
it does not produce, it becomes to some extent 
dependent upon other nations for the satisfaction 
of wants. 

Dependence is not, however, necessarily an evil. 
It is absolutely inseparable from all progress and, 
when the development is healthy, there results in- 
creased efficiency and a higher ci^dlization. But 
there is a possibilitj' of evil in the relation of de- 
pendence, a possibility which becomes a reality 
when the proper balance is not preserved. 

Excessive dependence may be due to the fact 
that the process of division of function is carried 
so far as to diminish the capacitj'' of an individual, 
undermine his health, stunt his mind and dis- 
tort his development, both mental and physical. 
Such a result is most likely to be seen where the 
process assigned to an individual is a simple, 
mechanical one, requiring endless repetition with- 
out variation throughout long hours. The result- 
ing decrease in vigor of mind and body is itself an 
evil. It indicates a defeat of the economic process. 
But this is not the only significance of excessive 
dependence. It impairs the process of production 
by reducing the efficiency of those subjected to such 
dependence. This effect becomes especially appar- 
ent when, as often happens, a change in industry 
takes place. Then the laborer, who was perhaps 
skilled in one kind of occupation, finds his training 
no longer in demand, and if he is unfitted for other 



122 THEORY OF ECONOMICS 

forms of work, he loses employment and sinks to a 
low state of economic efficiency. 

Of, again, disproportionate dependence may fol- 
low from the results of the distribution of wealth. 
Division of function necessitates the division of the 
product among the producers, and the conditions of 
distribution may be such as to injure the process of 
production. In the process of distribution there is 
a tendency for product to go to the strong, as a con- 
sequence of which the stronger may become more 
strong and the weaker, more weak. If this pro- 
motes the survival of the fittest, it may not in the 
end be a misfortune, but the immediate conse- 
quences are often deplorable, and the extent to 
which remedies are provided for these evils is one 
of the vital tests of the adequacy of any industrial 
system. 

59. A second evil incident to economic organiza- 
tion is overproduction. By this is not meant that 
more wealth is produced than can be consumed, but 
that there may at times be more of a commodity 
produced than sufiices to meet the effective demand 
for it, i. e. , the demand that is willing to pay the 
cost of producing it. When this happens, it is an 
indication of loss, for it means that the power of 
want-attraction which has been produced is not 
equal to that which has been expended. That this 
is a matter of common occurrence is shown by the 
frequency with which ' 'bargain sales' ' are instituted 
to dispose of accumulations for which no effective 
demand exists. Such losses may, however, be so 



777^ ECONOMIC ORGANIZATION 123 

slight as to cause no serious derangement of the in- 
dustrial machinery. But when overproduction takes 
place on a large scale, it becomes a serious menace 
to the efficiency of the economic process. 

The possibility of over-production emphasizes two 
important characteristics of the productive proc- 
ess: (1) it is not a purely spontaneous process in 
the sense that it proceeds independent of man's 
judgment, hence, (2) the process becomes increas- 
ingly speculative as the organization becomes more 
complex. The further division of function is car- 
ried, the less each individual produces directly for 
himself and the present. In producing for others 
and the future, one is compelled to form an estimate 
of the nature and amount of commodities that will 
be required by others. He cannot consult his own 
and the immediate demand only. Certain commodi- 
ties minister to wants which are so universal and 
persistent that there is never wanting some demand 
for them, but even in the case of these, which may be 
called "staple" commodities, the supply and, to some 
extent, the demand vary from year to year, so that 
judgment as to what shall be produced cannot even 
here be dispensed with. With other classes of com- 
modities which serve wants peculiar to certain sea- 
sons, waste and loss of efficiency is the more sure 
to result from a disregard of the varying character 
and extent of demand. The more susceptible wants 
are to fluctuation, the greater is the necessity for 
care in adapting supply to demand. 

As an inevitable consequence of the production 



124 THEORY OF ECONOMICS 

for others and the future, the element of specula- 
tion is introduced into the economic process. The 
same progress in division of function that increases 
the necessity for judgment in production, intensifies 
the uncertainty of the result, thereby rendering 
activity increasingly speculative. In like manner, 
variation in wants, which makes necessary a care- 
ful estimate of future demand, increases the specu- 
lative character of industry. Speculation is, then, 
never absent from economic activity where the 
cooperation of members of society is involved. 

Moreover, speculation is not without its advan- 
tages, since it compels the exercise of judgment 
and contributes to the development of a higher 
order of business ability. Furthermore, in influenc- 
ing men to look out for the future as well as for 
the present, there is a tendency to equalize 
economic conditions, thereby lessening the evil 
effects of such temporary emergencies as are caused 
by failure of harvests. But the possibility of gain, 
which accompanies the existence of speculation, 
sometimes leads to deliberate effort to make uncer- 
tainties in order that one may profit at the expense 
of another. The consequence of this may be a 
serious disturbance of business, the correction of 
which is rendered the more difficult by the fact that 
it is not easy to distinguish the speculation that is 
necessary and beneficial from that which is injur- 
ious. 



THE INCENTIVE TO ACTIVITY 



60. In addition to the factors of production and 
the economic organization, the character of the in- 
ducement to put forth effort exerts an important in- 
fluence upon the process of production. As has been 
said, the fundamental reason for activity is want. 
But the mere existence of a desire is not of itself 
sufficient to lead even to activity, much less to the 
most efficient activity. Besides the want, there 
must appear to the individual a direct relation be- 
tween his act and the satisfaction of his want. He 
must believe, on the one hand, that if he puts forth 
effort, he can attain his end; and, on the other 
hand, that if he does not exert himself, he will 
suffer a disadvantage. In brief, to the efficiency 
of the productive process it is essential that there 
should be a prospect (1) that gain will result from 
action and (2) that loss will result from inaction. 

While there is doubtless much difference between 
the motives to action, some men being impelled by 
a desire for larger growth and others seeking only 
the necessities of life, still, whatever be the specific 
motive, there would be little, if any, activity but 

125 



126 THEORY OF ECONOMICS 

for the expectation of profiting by the result. 
Moreover, it is not sufficient for efficient production 
that as the result of effort there should be a pros- 
pect that somebody's want will be satisfied, there 
must be a prospect of the satisfaction of the wants 
of him who sets the process going. It is true that 
activity is often found where the outlook for suc- 
cess seems well-nigh hopeless, but even here there 
will be found a belief that in the mere fact of 
activity itself is some prospect of reward, — more at 
least than in idleness. 

On the other hand, it requires only a superficial 
consideration of societ)^ to see that the economic 
process suffers from the inactivity of those whose 
circumstances lead them to think that their wants 
will be supplied without much activity on their 
part. In the possession of an income which the 
efforts of others and the institutions of society have 
provided and unmoved b}^ ambitions for higher de- 
velopment, they contribute but little to economic 
efficiency, because of the lack of an incentive to act. 

61. Assuming the existence of wants, the condi- 
tions which determine the incentives to activity are 
found largely in the character of the individual and 
in the rights established by society. 

The incentive essential to secure efficient action 
is not the same for all persons. Differences inher- 
ent in human nature ascribable to temperament and 
other elements of character, result in varying de- 
grees of natural hopefulness. Some men are con- 
fident of success where others foresee only failure, 



THE INCENTIVE TO ACTIVITY 127 

for no other reason than that the former naturally 
give greater emphasis to the favorable side of things 
than do the latter. 

Especially important in this connection is re- 
ligious faith, which influences economic efi&ciency 
not only by conditioning the character of the wants 
whose satisfaction is sought, but also by increasing 
the readiness to act. He who believes that an over- 
ruling Providence controls the affairs of men, not 
merely watching over the general trend of human 
affairs, but concerned also with the interest of in- 
dividuals, rewarding faithfulness, feels less need of 
Seeing the end from the beginning, than does one 
who is devoid of such a faith. And though hopeful- 
ness exaggerated may become rashness, and faith 
misapplied may lead to inaction, thereby lessening 
the efficiency of the economic process, both ele- 
ments of character are important factors in influenc- 
ing to healthy activity. To ignore them is to omit 
from the analysis of the economic process some of 
its most important phenomena. 

62. The incentive to activity depends also upon 
rights. A right is society's recognition of freedom 
to act to an end, a recognition involving both per- 
mission to do and protection in doing. Thus the 
right to life, the right to property and the right to 
free movement rest upon society's approval of the 
individual's claim to freedom to live, to own and to 
movd Rights have not always been the same. 
They have been established according to the condi- 
tions existing at different times and in different 



128 THEORY OF ECONOMICS 

places. But alwaj-s and everywhere their develop- 
ment has had this distinctive characteristic: they 
have been established according to society's concep- 
tion of the need of the individual for freedom of 
action. Their recognition has brought within the 
reach of the individual greater prospect of reward 
and has thereby given a greater incentive to activity. 

Nor is this view inconsistent with the fact that 
society's method of establishing rights is often by 
denial to individuals of the right to do certain 
things. Thus, society may establish the right to 
live by condemning and punishing murder; it may 
establish the right to property by forbidding steal- 
ing. But in all such cases, the real significance of 
society's decrees is not the limitation but the en- 
largement of freedom. By preventing one man 
from committing murder or robber)-, it enhances 
the freedom of a hundred who, as a result of those 
decrees, can the more freely act for the satisfaction 
of their wants. Where life and property are safe, 
men are no longer obliged to devote a large portion 
of their energy to suppl3ang for themselves the 
means of protection. To that extent energy is re- 
leased for other purposes. Moreover, this guarantee 
of protection vastlj^ increases the incentive to act 
b)^ increasing the prospect that one may enjoy the 
fruits of his efforts. 

63. The importance of rights to the process of 
satisfying wants will be more clearly seen b)' an 
examination of two that bear an especially close 
relation to the prospect of reward, viz. : the right to 



THE INCENTIVE TO ACTIVITY 129 

own and the right to contract. The right to own 
is, next to the right to Hve, the most important 
guaranteed to the individual by society, because, 
while the latter aims to insure existence, the former 
aims to make development possible. Indeed, the 
right to live in itself involves the right to own, 
at least to the extent of controlling the food 
without which life would cease. True, society, 
in establishing the right to live, does not recog- 
nize the right of every individual under all 
conditions to appropriate whatever is necessary 
to his life, but as a social institution there 
must exist, to some extent, the right to own or men 
would disappear and society would cease to exist. 
This is, however, considering the right to own from 
the standpoint of absolute necessity only, and had 
mere existence been the end sought, the right to 
property would have come far short of its present 
scope. Viewed in its relation to production, the 
right to own is a fundamental and omnipresent 
condition of efficiency. That as a result of one's 
efforts there should be ownership in the means to 
satisfy wants, is an indispensable requisite to prog- 
ress. Both man's immediate efforts and his dis- 
position to save for the future, one of the funda- 
mental requisites for capital building, are dependent 
upon property rights. 

Of the rights to property, the right to own 
one's self comes first in importance. Though slav- 
ery and serfdom, at some time in the development 
of society, may have suited the lequirements for 



130 THEORY OF ECONOMICS 

economic efficiency, they are to-day recognized by 
all the most advanced nations as utterl}' incompat- 
ible with a high grade of industry. He who has 
not property in himself cannot be expected to be 
interested in doing all that he can in the best pos- 
sible way. If one knows that even his supply of 
life's necessities is at the arbitrary disposal of a 
master and that no matter how efficient he maj^ be, 
his reward is wholly at the pleasure of some one 
else, the incentive to act is of the lowest order. As 
has been said of the slavery system, the individual 
under it has "no rights," "no property in prod- 
uct,' ' and his ' 'pay is determined by animal wants, ' ' 
hence he has "no interest in the quantity or quality 
of the work done nor in the care of materials." ^ 
Whenever, under slaverj^ there exists a higher 
grade of efficiency than is needed to maintain life 
and escape punishment, it will be found due to 
affection or to a sense of duty, traits of human 
character which even slavery cannot wholl}' eradi- 
cate. So far as rights are concerned, the right to 
own one's self is the first condition of efficient 
activity. 

But society has not stopped with establishing 
the right to property in one's self. It has added 
to this the right to property in the means for satis- 
f5dng wants, a right that has varied in its compre- 
hensiveness from time to time according as society 
has viewed the needs of efficient activity. In very 

1 Henry C. Adams, Outline of Lectures upon Political 
Economy, p. 12. 



THE INCENTIVE TO ACTIVITY 131 

early times, it is not improbable that the individ- 
ual's right to property was limited to what is 
known as personal property, which then consisted 
mainl}^ of the implements of the chase and formed 
a comparatively small part of the entire wealth of 
societ}^ It is not difficult to see how these limits 
to private property were essential at that time to 
economic efiicienc3^ The principal commodities 
sought for the satisfaction of wants were wild ani- 
mals and fish. As these had no fixed habitations, 
to have limited fishing or hunting grounds for each 
individual to certain definite areas of water or land 
would have rendered existence even more precari- 
ous than it was. On the other hand, the principal 
incentive to the manufacture of good bows and 
arrows, canoes and tents, was the knowledge that 
as the property of the maker they would contribute 
to his welfare. 

In time, the growth of society necessitated the 
cultivation of land and with this came a limita- 
tion of common ownership, looking towards private 
property in land. In the system that prevailed in 
the Middle Ages, though common rights still ex- 
isted in connection with land, they were so far lim- 
ited as to entitle the cultivator to a definite quantity 
of land. And though this did not involve perma- 
nent possession of definite pieces of land, still the 
control of such definite portions was vested in the 
cultivator until he secured his crop. I^ater, it be- 
came necessary to fertilize the soil and otherwise to 
add improvements of a relatively permanent nature, 



132 THEORY OF ECONOMICS 

and as the benefits from these improvements could 
not be realized adequately in one season, longer con- 
trol was necessary in order to supply the requisite 
incentive. Finally, private property in land was 
established as a right. Though other factors 
doubtless entered into the development of private 
property in land, those here given illustrate its 
general character. Indeed, fraud and even force 
may have been features of the actual process of 
development, but the final establishment of the 
right to private property in land was due to the 
fact that society recognized private ownership as 
more efiicient than common ownership because 
there resulted greater incentive to high grade culti- 
vation. 

Two other property rights bear an especially 
close relation to the incentive to activity, the patent- 
right and the copj^right, in the establishment of 
which society has expressly sought to offer induce- 
ments to efl&cient effort. The patent-right seeks to 
insure to the inventor control over the supply of 
his invention, which might otherwise be lost 
through the greater ability of others to produce it 
after they had secured the plan. The copyright 
seeks to secure a similar advantage to the author. 
The marvelous development of inventions and their 
vital relation to industry have been mentioned. 
Though, as has been pointed out,^ the economic 
organization supplies conditions favorable to the 
development of ability to invent, it may be consid- 



THE INCENTIVE TO ACTIVITY 133 

ered certain that few of the great inventions which 
are revolutionizing economic methods would have 
been made, but for the guarantee by society of 
property rights in such products. Nor is the truth 
of this altered by the fact that in many instances 
the reward for an invention has not been reaped 
by the inventor. The hope of such reward existed 
because of patent-rights, and this gave the neces- 
sary incentive to act. 

A similar incentive to activity is found in the 
copyright, but for the existence of which, many of 
the ablest minds the world has seen would have 
been unable to devote their energies to literature, 
in which case society would have suffered irrevoca- 
ble loss. Nor is it in the realm of mere culture 
alone that the copyright aids production. The 
general progress of economic efficiency has been 
due in no small degree to the contributions of 
science. These contributions appear not. only in 
the form of apparatus and processes that can be 
patented, but also in the form of scientific treatises, 
property in which is insured by the copyright. 
Fundamentally, however, there is little difference 
between the so-called patent-right and the copy- 
right. Both seek to encourage activity by increas- 
ing the prospect of reward through property rights 
in the result. 

64. It is not, however, to be inferred, from the 
existence of private proper tj^ rights, that the right 
of control resulting is absolute and unlimited. 
Property rights are the creation of society and it 



134 THEORY OF ECONOMICS 

rests with society to establish such limitations as it 
may deem best. Moreover, such limitations are by 
no means rare. They are found in connection with 
the management of railroads, in the exercise of the 
right of eminent domain and in many other forms. 
Even where the legal title to the ownership of rail- 
roads is vested in private persons, society insists upon 
imposing such restrictions upon private control and 
even upon exercising such oversight as in its opin- 
ion public good demands. These restrictions upon 
private control are substantially limitations of 
property rights, for from the standpoint of its 
essential character, if not in a technical legal sense, 
the right to own is the right to control. 

The fundamental reason for limitations upon pri- 
vate property rights lies in the fact that it is quite 
within the possibilities that private property should 
at times so obstruct activity as to diminish economic 
efficienc5^ Thus the institution of the right of emi- 
nent domain, whereby society reserves to itself the 
right to appropriate certain forms of private prop- 
erty for public use, rests upon the fundamental fact 
that individual choice as to the use of property may 
conflict with society's conception of public good. 
In order that this limitation to individual control 
ma}^ not work a disadvantage to society, the right 
to compensation for property taken for public use is 
generally, though not always, recognized. But the 
fact that the amount of such compensation, as well 
as the appropriation of the property itself, are not 
left to the decision of the owner, makes the right 



THE INCENTIVE TO ACTIVITY 135 

of eminent domain an important limitation to the 
right of private propert3^ 

To appreciate the power of evil in unrestricted 
private ownership and control, one needs but to 
picture the conditions that would exist in the ab- 
sence of this right of eminent domain. There is 
no more important requisite for economic efficiency 
than freedom of movement. Freedom of move- 
ment, however, requires not only the absence of 
legal restrictions upon such movement but also 
routes along which the individual may move. It is 
impossible to estimate the importance of highways 
to society or the impediment to activity that would 
result from leaving their existence and location to 
the will of the private owner. 

Moreover, society' s restrictions upon private prop- 
erty rights are not limited to such quasi-public 
undertakings as railroads, nor to the actual diver- 
sion of property from private to public use. In 
forbidding a man to erect a slaughter-house at will 
within a citj^'s limits, in requiring of factory owners 
suitable fire-escapes and guards for dangerous ma- 
chinery and in other similar restrictions, society 
limits private control of property. Such limitations, 
though they may not affect the legal title, are in 
substance limitations of private property rights, 
for these, as has been said, are, philosophically 
speaking, rights of control. 

In various forms, a desire to limit still fur- 
ther the rights to private property is manifested. 
The most extensive of the schemes proposed is that 



136 THEORY OF ECONOMICS 

of the socialists, who would make all the facilities 
for production, except labor, public property. In 
a more moderate form, the same dCvsire appears in 
the plan of the single tax advocates, who would 
make land public property. Others propose public 
ownership of railroads and municipal monopolies, 
such as water-works and lighting plants. These 
schemes cannot consistently be condemned merety on 
the ground that they involve limitations of private 
property rights, for unlimited private property rights 
do not now exist. In deciding the merits of these 
and similar propositions, the matter of chief concern 
is the resulting effect upon the incentive to activity 
in its relation to the efhcienc}- of the industry in- 
volved and to the economic process in general. For 
the limitations of private propertj' rights, if carried 
too far, would diminish the efficiency of production 
(1) b}' lessening the incentive that comes from hope 
of gain and leads to intense effort; and (2) by 
substituting for hope of reward for one's efforts, 
hope of reward without effort or out of proportion 
to effort. Such results are fatal to economic prog- 
ress because they destroy the requisites there- 
for. However desirable a fair distribution of prod- 
ucts may be, there must first be products to divide, 
and efforts to secure a fair distribution which 
lessen the efl&ciency of production, may defeat 
their own end. 

65. A second right referred to as vitally related 
to economic efficiency is the right to contract. The 
right to contract involves freedom to enter into 



THE INCENTIVE TO ACTIVITY 137 

agreements and the assurance that the power 
of society can be relied upon to secure their 
performance. Agreements between members of 
society are the direct outcome of division of 
function, as a result of which men produce less for 
themselves directly and for the present, and more 
for others and the future. Under such conditions, 
agreements as to future performance are a prereq- 
uisite for present action. But the individual un- 
aided can with difficulty compel the fulfillment of 
obligations. The weak would be at the mercy of 
the strong, were it not for the superior power of 
society which can be invoked when necessary. 
Wherever one's prospect of reward depends at 
all upon the obligations of others, an adequate 
incentive to act cannot rest merely upon the 
willingness of the others to do their part. 
Moreover, under the existing order of things, 
there are few instances in which one's efforts to 
satisfy his wants do not depend in some degree 
upon others for their success. Society' s recognition 
and enforcement of contracts tend to insure to the 
laborer the returns agreed upon for his services; 
they make possible the flow of capital through 
loans to the place where it can be most efficiently 
used; and, as an accompanying result, they enable 
the collection and more efficient utilization of small 
savings, thus diminishing loss through waste. 

The importance of contracts to production is en- 
hanced by the extent to which under modern econ- 
omic conditions, the owners of the factors of produc- 



138 THEORY OF ECONOMICS 

tion do not come into immediate control of the prod- 
uct. When the owners of capital, situation and la- 
bor are not themselves managers of an undertaking, 
they must rely upon others for their returns from 
the industry. The finished product comes into the 
immediate control of the proprietor of the industry 
and contracts are necessary to insure its proper dis- 
tribution. In a shoe factory, for example, the 
plant, raw materials and labor may be owned by 
others than the proprietor. His ability to obtain 
the use of these factors will depend in no small 
degree upon contract, for the finished shoes come 
into his immediate possession, and however honest 
he may be, the owners of the factors will expect an 
agreement, enforceable at law, before allowing the 
use of their property. The conditions are further 
complicated by the fact that the finished product is 
often not suited for the pajanent of the owners of 
the factors of production. The owners of the plant, 
of the materials and of the labor do not want their 
pay in shoes. The proprietor is expected to sell 
the shoes upon the market and to pay his obliga- 
tions in a medium of exchange. In every step of 
the process, contracts enter, and their status is an 
important condition of efiiciency. 

The close relation of contracts to economic effi- 
ciency is seen also in connection with the use of 
credit in the process of buying and selling. The 
development and usefulness of division of function 
require an exchange of commodities, and to facili- 
tate exchange it has been found necessary to em- 



THE INCENTIVE TO ACTIVITY 139 

ploy credit. Indeed, the vast majority of business 
transactions are conducted without the actual trans- 
fer of money. At the very foundation of credit is the 
inviolability of contracts. Not sentiment, nor per- 
sonal friendship, but legally enforceable agreements 
are the basis of business credit, and no highly de- 
veloped credit system can be found where the insti- 
tution of contract is not well established. 

So important does society regard the matter of 
contracts, that it often allows an obligation to be im- 
plied in the absence of express agreement. Thus, 
"if a person continues to receive a paper or periodi- 
cal sent through the post-ofifice, he is liable for the 
subscription price. "-^ His acceptance of the paper 
implies an agreement to pay for it. It is held also 
that a "common carrier intrusted with goods im- 
pliedly promises to carry and deliver them safely."^ 
It is stated as a general rule, that "a promise will 
be implied or created by law where equity or good 
conscience require one, even though none were 
especially made. ' ' Ample warrant for society's con- 
cern as to contracts is found in their vital relation 
to that prospect of reward which is essential to 
ef&cient activity. 

Society places limitations upon the right to 
contract, as it does upon property rights, be- 
cause of the evils which might otherwise result. It 
is to the interest of society that both parties to a 
contract should be as free as possible, or at least 

1 I^awson, Contracts. Sec. 43. -Ibid., Sec. 49. 



140 THEORY OF ECONOMICS 

that neither should be under any other compulsion 
than such as makes for his good. Hence in a large 
number of instances, undue influence is held to be 
sufficient ground for invalidating a contract.^ Thus 
a contract whereby an employee releases his em- 
ployer from liability in case of injury is often held 
to be void. Furthermore, many contracts in re- 
straint of trade, though freeh^ entered into by the 
parties, are declared illegal because considered to be 
against public interest.^ As a general principle, 
societ}^ no longer enforces the actual fulfillment of 
contracts involving personal performance, for such 
a policy would be too akin to slavery to be consist- 
ent with society's good. In all these cases, as 
with property rights, the demands of economic 
efficiency will be found upon analysis, to be a deter- 
mining factor in settling the limits to the right to 
contract. 

66. Closely akin to the right to contract but so 
important as to justify special consideration, are 
the rights through which society seeks to increase 
the incentive to activit}' by directly limiting liability 
to loss. With the progress of society, the individ- 
ual tends more and more to share with others the 
control of the conditions of his success. This, as 
has been seen, is a direct result of division of func- 
tion and leads to the dependence of members of 
societj' upon each other. Under these conditions, 

1 Lawsou, Contracts, Sec. 259 et seq. 

-Ibid., Sec. 324 et seq. An excellent statement of the 
social status of contracts can be found in this treatise. 



THE INCENTIVE TO ACTIVITY 141 

there is a tendency to seek the increase of the pros- 
pect of reward by guaranteeing the individual 
against the full consequences of his failure to suc- 
ceed, thereb}^ diffusing responsibility. Thus society 
authorizes associations in which the liability of 
each member of the organization is limited, usually 
to some proportion of his share therein. 

lyimited liability is one of the prominent features 
of joint-stock companies and corporations.^ In 
these companies the management is placed in the 
hands of agents, who may or may not be part own- 
ers, and upon their judgment the success or failure 
of the undertaking largely depends. In many cases 
the risk involved is so great that the industry would 
not be undertaken if each one joining therein were 
to be held liable for the entire loss in case of failure. 
But men are willing to share in such associations, 
even though not personally in control of their con- 
duct, because of the possible advantage in case of 
success and of the limited liability to loss in case of 
failure. This form of business organization, origin- 
ally necessitated by the exigencies of large under- 
takings, has proven so advantageous to the par- 
ticipants, that many small establishments have re- 
organized as stock companies. 

The advantages to society of such a method of 
organization are very great and should not be lost 
sight of in the presence of the evils to which 

^The term "corporation" strictly speaking includes mu- 
nicipalities and many religious and social organizations as 
well as those established for business purposes. 



142 THEORY OF ECONOMICS 

it is susceptible. Corporations enable society to 
profit by the superior possibilities of large busi- 
ness enterprises without the loss in incentive to act 
which would result, were all industries that are too 
large for a single individual, to be placed in charge 
of the state. But corporate organization in foster- 
ing large industries promotes concentration of 
power of control and hence may be lead to the 
evil possibilities of monopolization. And, in estab- 
lishing the right to engage in business with 
a limited liability as to the consequences of 
one's acts, society owes it to itself to guard 
against the abuse of this privilege. In some re- 
spects this is one of the most pressing of social 
problems. Many of the evils ascribed to monopoli- 
zation are due to defective corporation laws. But 
in correcting these evils, great care should be taken 
not to allow a rash judgment as to the results of 
corporate organization to obscure the important 
advantages accruing to society therefrom. 

Somewhat similar to the limited liability of cor- 
porations, in that it limits one's liability to suffer 
the complete consequences of failure, is the institu- 
tion of old age pensions. Under modern economic 
conditions many men are compelled to rely solely 
upon their own labor to secure the satisfaction of 
wants, as a result of which, members of this class 
at times fail to make adequate provision for 
old age. It is believed by some that this failure is 
not primarily the fault of the persons concerned but 
is due in part to modern industrial organization. 



THE INCENTIVE TO ACTIVITY 143 

This belief has led to the establishment, in some 
countries, of old age pensions for the workingmen, 
which, by a guarantee against future need, tend to 
relieve workingmen from undue anxiety. In their 
relation to the incentive to activity, these pensions 
are in substance attempts to avoid loss of efl&ciency 
through despair. Fear of loss is but the opposite 
of hope of gain, and however they may differ in 
their effects upon individuals, their results agree in 
in this: that excessive hope of reward which be- 
comes rashness, and excessive fear of loss which 
becomes despair, are alike injurious to the produc- 
tive process. 

As social problems, the detailed discussion of 
corporations and pensions lies outside the scope of 
the present investigation. Nor do the rights of 
property, of contract, of corporate organization 
and of pensions, exhaust the social institutions 
which affect economic eflBciency. They may, how- 
ever, be considered sufficient to illustrate and empha- 
size the close connection between the legal institu- 
tions of society and the incentive to activity which 
is essential to efl&cient production. 



THE DEVELOPMENT OF DEMAND 



67. The first requisite for economic demand is 
population/ and except when the increase in popu- 
lation so far exceeds the increase in commodities as 
to lower the standard of living, it may be said that 
the larger the population the more effective is the 
demand for commodities. The extent of popula- 
tion depends primarily upon the procreative capac- 
ity of the race, a question that is physiological in 
character. But a high birth-rate does not neces- 
sarily result in a numerous population. The tend- 
ency of population to increase as a result of births 
is in some measure offset bj^ its decrease through 
deaths. And though death is certain for all human 
beings, its influence is increased by the numerous 
causes which prevent many from attaining what 
may be called a normal age. Only a small propor- 
tion of men die as the result of the natural decay 
of physical energy through old age. Disease, acci- 
dent, war, pestilence and crime, in a multitude of 

1 Throughout this discussion of demand, the existence of 
commodities is assumed. 



THE DEVELOPMENT OF DEMAND 145 

forms, shorten the normal period of Hfe and tend 
to depopulation. 

The fact of the necessity of a large population 
to a high grade of economic progress, both as 
affording the necessary labor power and enterprise 
and also as supplying that variety and extent of 
demand without which the scope and efficiency of 
activit}^ must remain limited, has been obscured by 
the emphasis given, since the time of Malthus, to 
the possible evils of over-population. Malthus 
pointed out the fact that: "There resides in nearly 
all races and tribes of men, a strong, urgent, per- 
sistent disposition to carry the increase of popula- 
tion beyond the limits of adequate subsistence."^ 
It is, of course, impossible that population should 
continue to increase faster than subsistence, because 
without adequate subsistence, the death-rate would 
offset the birth-rate. But it is conceivable that 
population should increase to the limit of bare sub- 
sistence, in which case mankind would be con- 
stantly on the verge of starvation. This question 
of the possibility of over-population and the prope 
remedy therefor belongs to the discussion of social 
problems. It has, however, an important bearing 
upon the present inquiry, in that it suggests the 
fact that the efficiency of demand depends not 
merely upon the number of people but also upon 
their standard of living. 

68. The standard of living attained by a people 

^ Walker, Political Economy, p. 313. 



146 THEORY OF ECONOMICS 

is conditioned bj^ the extent and character of the 
development of wants. The fundamental charac- 
teristic of the development of wants is the fact that 
new wants arise through the satisfaction of existing 
wants. Wants satisfied beget other wants, or bet- 
ter, perhaps, wants satisfied enable other wants 
relatively less intense to assert themselves. The 
process of development is from the general to the 
particular. First there exists a general want, per- 
haps unexpressed, either unsatisfied or capable of 
better satisfaction; then a commodity is found 
which will meet the want, after which the want 
turns to the specific object and there results eco- 
nomic demand. To illustrate in the case of cotton- 
seed, already mentioned, there existed first the 
general want for a better food supply ; then it was 
found that cotton-seed would meet this want, and 
the want turned to the specific object; there arose 
a demand for cotton-seed and its products. A sim- 
ilar illustration is found in the case of the tomato, 
which now contributes so extensively to the food 
supply. Formerly this ministered only to a lim- 
ited aesthetic demand. It was cultivated as a 
garden ornament. But it became known that it 
was good to eat, and a portion of that general 
demand for a better food supply, which is always 
pressing for satisfaction, became centered upon 
tomatoes. 

It should be noted also that a vital relation ex- 
ists between effort and the development of wants. 
By this is meant not merely that effort is necessary 



THE DEVELOPMENT OF DEMAND 147 

to secure that which will satisfy wants and hence 
to the development of new wants, but that to some 
extent effort is a direct cause of the development of 
wants, and is, therefore, economically useful in and 
of itself. A condition in which wants could be 
satisfied without effort is as undesirable as it is 
impossible. 

The relation between effort and development can 
be described only in general terms and is not sus- 
ceptible of quantitative determination. It is subject 
to great variations, because it is dependent upon a 
variet}^ of conditions. It is not to be inferred 
that, because some effort is desirable, therefore 
the greater the effort necessary to the satis- 
faction of wants, the better. Too great effort 
means exhaustion. But it would be equally erro- 
neous to affirm that the less the effort the better, 
for too little effort means stagnation. It is not an 
accident that the highest development has been 
attained in the temperate rather than in the torrid 
zone where nature is so generous that the necessi- 
ties of life require only to be appropriated, or in the 
frigid zone where the conditions are so hard that 
it requires nearly all of one's effort to maintain 
existence. Nor does the fact that so much activity 
in industry is devoted to decreasing the cost of pro- 
duction disprove the statement that effort is in itself 
to some extent useful. Whatever may be the spe- 
cific motive of him who seeks to make the condi- 
tions of satisfying wants easier, the result of the 
attainment of this end is not idleness. In its rela- 



148 THEORY OF ECONOMICS 

tion to the economic process, the attempt to de- 
crease the cost of production is not an eifort to 
attain rest, but rather a striving to save energy in 
one direction that it may be available in some 
other, i. e. , it is struggle for higher development. 

Wants develop, then, through the satisfac- 
tion of wants, /. e., through consumption. But 
not all wants sustain the same relation to eflficiency 
of demand. It is not merel}- the general fact of 
want-development but the kind of want-develop- 
ment also that conditions demand. An analj'sis of 
the character of wants is necessar}-, then, to deter- 
mine the relation of consumption to demand. The 
subject of inquiry here presented has usually been 
ignored in the investigation of economic principles, 
on the ground that it pertains only to the domain 
of the moralist or the sociologist. Because the 
satisfaction of wants is the end of activity, it 
seems not to be sufficientl}- recognized that this 
end becomes also a means, hence the satisfaction of 
wants must itself be taken into account in deter- 
mining the conditions of economic efiSciency. 

Furthermore, it is too often assumed that the 
nature of demand itself need not be taken into 
consideration, and that the economist should con- 
cern himself only with an analysis of the way 
in which demand is met. This is, however, 
to ignore an important phase of the economic 
process and to leave the resulting presenta- 
tion of principles incomplete. It should be ob- 
served also that though the investigation here 



THE DEVELOPMENT OF DEMAND 149 

approaches the domain of ethics, the point of view 
is different. It is not proposed to inquire into the 
right and wrong of different wants, but into their 
varying effect upon economic efficiency in so far as 
that depends upon demand. The ethicist may hold 
that this determines the right or wrong character 
of wants and of the resulting activity, /. e., that 
whatever ministers to human development is right 
and that whatever retards it, is wrong. With this, 
however, the economist, in so far as he seeks funda- 
mental economic principles, is not concerned. For 
with him the sole question in this connection is, 
how do wants affect the efficiency of demand. 

69. The chief characteristics of v/ants that con- 
dition their influence upon demand are (1) persist- 
ence, (2) expansibility and (3) healthfulness. The 
moie persistent wants are, the more effective is the 
resulting demand, unless some other characteristic 
renders them destructive. For the greater the per- 
sistence of wants, the more effective are they in im- 
pelling to action for their satisfaction, and the more 
certain is it that the supply adapted to the wants 
and the adjustment of economic forces for the pro- 
duction of that supply, will continue effective. This 
is the characteristic popularly called "steadiness." 
A steady demand diminishes the uncertanties of 
business, decreases the speculative character of 
undertakings, and limits the field of the unscru- 
pulous member of society. 

The recognition of the fact that wants vary in 
the degree of their persistence is reflected in the 



150 THEORY OF ECONOMICS 

popular classification of commodities as necessities, 
comforts and luxuries. It is impossible to draw 
hard and fast lines between commodities tJn this 
basis of classification, but it corresponds in general 
with the fact that some wants are in the highest 
degree persistent, because suffering and death result,' 
if they remain unsatisfied; others are less persistent, 
because their satisfaction is only a matter of con- 
venience; while others are still less persistent be- 
cause concerned only with pleasure. But suffering, 
convenience and pleasure, like necessities, com- 
forts and luxuries, are purely relative. That which 
ministers to the convenience of one, may prevent 
positive suffering in another; while that which is 
merely a matter of pleasure to one, is often essential 
to the convenience of another. 

The persistence of wants depends largelj' upon 
the physical nature of individuals and upon 
habit. Some things minister to the continuance of 
phj'sical existence; these are necessities in the 
strictest use of the term. The demand for such 
commodities is fundamental and is found in all 
stages of development. Under existing conditions, 
it is the most potent influence impelling to activity. 
In some instances, it alone prevents absolute idle- 
ness. But where these wants only are found, the 
.standard of living is of the lowest .sort. Above it 
are standards of all grades up to the highest, which 
must continue to move still higher, if civilization is 
to continue to advance. 

These standards and the persistence of the accom- 



THE DEVELOPMENT OF DEMAND 151 

panjdng wants are largely influenced by habit. The 
want which appears at first incidentally and appar- 
ently, it maj^ be, by accident, once gratified, recurs 
to seek new satisfaction. At each new recurrence, 
there is a tendency to increased persistence until a 
habit is formed and an element in the standard of 
living becomes fixed. 

70. A second characteristic of wants that in- 
fluences demand, is expansibility. Taking w^ants as 
a whole, it may be said that their capacit}^ for 
development is indefinitely great. This is a result 
of the nature of man, and its bearing upon the eco- 
nomic process is very significant. It forbids a con- 
templation of the time when, even though pop- 
ulation should no longer increase, a fixed condi- 
tion of want-development will be attained. The 
complete and final satisfaction of wants is impossi- 
ble even though the supply of commodities avail- 
able at a given time sufficed to meet all the wants 
then active. Certain wants recur at more or less 
frequent intervals, as in the case of the wants for 
food, clothing and fuel. Hence, though these were 
completely satisfied at a given time, such satis- 
faction would not be final. But, not only do cer- 
tain wants require repeated satisfaction, it is also 
true that new wants are constantly appearing. And 
judging from experience, the conclusion is war- 
ranted that there is no end to tJie capacity of man- 
kind to develop wants. In other words, it can never 
be predicated that existing wants can be no better 
satisfied and that no new wants can appear. The 



152 THEORY OF ECONOMICS 

expansibility of wants makes for the efficiency of 
demand. 

Not all wants, however, are alike in their expan- 
sibility, and in this fact, as well as in the varying 
persistence of v>^ants, is a cause, of difference in the 
effect of wants upon demand. The fact of differ- 
ences in the expansibility of wants has not, as a 
rule, been considered of sufficient significance to be 
recognized in economic discussions. This is due 
not only to a belief that demand can and will take 
care of itself, but also to the concentration of atten- 
tion in matters pertaining to economics, upon the 
physical wants and the commodities ministering 
thereto. In general, the physical wants, though 
more persistent, are less expansible than the 
non-physical or, as they may be termed, spirit- 
ual wants. The want for food, in so far as it arises 
from the requirements for maintaining life, does not 
vary greatly in amount for each individual from age 
to age. The want for clothing, fuel and shelter, in 
so far as those commodities are necessary as a pre- 
ventive of physical suffering, has increased to some 
extent because of changed habits of life; certain 
forms of activity lessen the hardiness of the body 
and increase the requirements for protection from 
cold. In the main, however, the large possibilities 
of development are found in the domain of the 
spiritual wants, such as the desire for esteem, 
knowledge, power and the beautiful. These are 
the wants whose expansibility leads to the great in- 
crease in demand. Even where the increase in de- 
mand calls for more elaborate and expensive food, 



THE DEVELOPMENT OF DEMAND 153 

it is chiefly due to the addition of the spiritual 
to the physical element of wants. Where an in- 
dividual spends large sums of money upon clothing, 
it is due not so much to a desire for warmth as to a 
desire to conform to style and to satisfy an aesthetic 
taste. The same is true of the demand for elabor- 
ate and expensive dwellings. 

The greater persistence of physical wants and 
the greater expansibility of those wants which 
may be said to arise out of man's spiritual nature, 
are illustrated by an investigation of actual ex- 
penditures among certain classes of society in 
Prussia. Though this inquiry did not include 
those whose incomes exceeded $1,100 a year, thus 
omitting those whose expenditures would show the 
greatest development of spiritual wants, the results 
are important in their general bearing upon the 
question of the development of wants. The ex- 
penditures were grouped in eight classes, viz., (1) 
subsistence, (2) clothing, (3) lodging, (4) firing 
and lighting, (5) education, public worship, etc., 
(6) legal protection, (7) care of health and (8) com- 
fort, mental and bodily recreation. A comparison 
was made of expenditures for these several classes 
of commodities under three classes of income, viz. , 
(1) $225-$300, (2) $450-1600 and (3) $750-$l,100. 
The results showed that the expenditures for the 
first four classes of commodities, which include 
those in which the physical wants are most promi- 
nent, were 95%, 90% and 85% for each of the 
three grades of income respectively, leaving for the 



154 THE OK y OF ECONOMICS 

second four classes of items, where the iufliieuce of 
the spiritual wauts is more marked, 5%, 10% and 
15% for each of the three grades of income. If it 
were possible to distinguish between the purely 
physical and the spiritual wants represented in the 
increase of expenditures for subsistence, clothing, 
lodging, firing and lighting, in the case of the larger 
incomes, there is little doubt that the increase in 
relative expansibility of spiritual wants would be 
found nuich greater than appears from the figures 
given.* 

71. The third characteristic of wants mentioned 
as influencing the efficiency of demand is heathful- 
ness. A want is healthful from the standpoint of 
economics when it is of such a wholesome character 
that its satisfaction conduces to the maintenance of 
human energy and to the further growth of health- 
ful wants. Some wants call for that which kills; 
others for that which nourishes and promotes de- 
velopment in ever increasing measure. From the 
side of their healthfulness, wants may be distin- 
guislied according as they require for their satisfac- 
tion food or poison, considering these terms to apply 
to spiritual as well as to physical wants. For ex- 
ample, from an economic standpoint, the want for 
nourishing food promotes economic efficiency, not 
only by increasing man's efficiency as a laborer or 
entrepreneur, but also by contributing to the effi- 
ciency of demand through its effect upon the fur- 

' IMassaclmsetts Bureau of Labor, Report for ISSo. Reprint 
edition, p. 'IhO. 



THE DEVELOPMENT OF DEMAND 155 

ther development of wants. On the other hand, the 
want for stimulants, except when concerned with a 
temporary emergency, is economically detrimental 
in two ways; — it undermines man's energy, thereby 
decreasing his effectiveness for producing commod- 
ities, and it obstructs the growth of healthy wants, 
thereby retarding the development of an efficient 
demand. A want may be -both persistent and 
expansible, but if its satisfaction is unhealthful, its 
ultimate effect is to diminish economic efficiency. 

72. A further condition affecting the develop- 
ment of wants is found in the relation of interde- 
pendence existing between certain classes of wants, 
so that, even though the germs of all wants may 
exist in the lowest stage of human development, it 
is not a matter of indifference, which wants first 
receive attention. It has been seen that physical 
wants, though less expansible than spiritual, are 
relatively more persistent. It is also true that the 
phy.sical wants are finst in order of development, 
and that their satisfaction is the first requisite for 
the development of the spiritual wants. This fact 
may well receive attention in view of the frequent 
efforts at social reform directed immediately towards 
man's .spiritual nature, when the physical wants 
are still very inadequately met. It is a fundamental 
economic truth that until at least the necessities of 
life are provided, .spiritual wants can find but little 
opportunity for development. On the other hand, 
it is equally true that the physical wants may be so 
satisfied as to obstruct the growth of .spiritual wants. 



156 rNEO/^r OF £CVXi\V/CS 

Both exhausting struggle for physical existence and 
excessive gratification of j>hysical appetite tend to 
smother the higher wants, 

7o. In so far, then, as demand involves the ex- 
istence of wants, the efficiency of the process of 
producing demand depends upon the degree to which 
existing wants are satisfied, the character of the 
wants satisfied and the order in which they are 
satisfied. Economic demand, howex'er. requires not 
only the existence of general wants but also the 
concentration of those wants upon specific commod- 
ities, for only then does want-attracting power 
restilt. This concentration of wants upon commod- 
ities, depends (1) upon a knowledge of the exist- 
ence and character of commodities and (^'^ upon a 
prospect of success in the effort to secure them. 

The effort to obtain a knowledge of the character 
of commodities is an important feature of business 
activity. Scientific in\-estigation is readily recog- 
nized as a prominent and essential feature of indus- 
tr>\ Its importance to economic progress is not 
questioned. In many industries, experts are con- 
stantly employed whose sole duty it is to investigate 
the quahties and possibilities of material in order to 
determine its adaptability to certain purposes. The 
results of such investigations determine largely the 
demand for those commodities. 

Another phase of the process of concentrat- 
ing general wants upon specific commodities is 
commonly called advertising. Evidences of this 
form of acti\-ity are omnipresent. B>" displays in 



7//A n/:Vh/J)PM/CNr 01' UEMAPJU Jr,7 

show-windows, by elaborately i>rei>ared and pro- 
fusely illustrated descriptions in newspaf^ers, maga- 
zines, circulars and other spedal publications, by 
exj>ositions or fairs, by si^^cial aj^ents, by signs and 
a multitude of other devices, human ingenuity 
exerts itself to the utmost to attract the attention 
of the consumer and secure his demand. 

Advertising has usually received the attention of 
the student of social phenomena, if at all, only to 
be condemned as a useless expenditure of energy. 
It is sometimes urged as an argument in favor of 
substituting government for individual initiative 
and control, that the former would render advertis- 
ing unnecessary and thereby save to society the 
energy now expended upon it. According to this 
view, advertising is simply a device to draw demand 
from one source of supply to another. As such, it 
is conceived to be of advantage only to this or that 
individual, according as one succeeds in diverting 
trade to hinuself, so that, inasmuch as what the 
successful advertiser gains another loses, the net 
result to society is the lo.ss of energy expended in 
advertising. Few views on economic subjects in- 
volve more serious error. 

It is doubtless true in the matter of advertising, 
as in all other phases of the economic process, that 
there is loss because of misdirected energy. But 
the results of advertising do not consist merely or 
necessarily in promoting the interests of one in- 
dividual at the expense of another. Advertising is 
a means whereb}' general wants, which would other- 



168 THEOJ^y OF ECOXOMICS 

wise remain general, are crystallized into specific 
wants for particular commodities. Furthermore, 
advertising not only convej's a knowledge of where 
and how things that are wanted, may be obtained; 
it tends also to develop a demand which did not be- 
fore exist, for one often wants sometliing as a result 
of knowing that it can be obtained. In all this, it 
performs an immense sen-ice to society. Indeed, the 
service of advertising is one that, in the modern 
highly developed organization, is absolutely indis- 
pensable to economic efficiency. 

Nor is the effect of advertising in diverting trade 
from one party to another, necessarily an evil. In 
doing this, it may be promoting the sur^-ival of the 
fittest and thereby contributing to economic prog- 
ress. Society will undoubtedly gain in economic 
efficiency by improvements which will enable the 
results of advertising to be attained ^^•ith less ex- 
penditure of energy, just as it profits by improved 
machinery or training, or by any other change which 
increases tlie effectiveness of its applications of 
energy. But to condemn advertising as a waste of 
energy merely because the futiure may see less ex- 
pensive methods employed, is as illogical as to de- 
clare that the old hand printing-press was a useless 
contrivance because it has been found possible to 
substitute for it a more economical machine. The 
loss of energ>- which, in the absence of advertising, 
would result through the continued use of relatively 
inefficient methods, far surpasses the entire expend- 
iture of energy therefor. To appreciate its impor- 



THE DEVELOPMENT OF DEMAND 159 

tance one needs only to contemplate the condition 
that would result if this feature of the economic 
process did not exist. The high grade of modern 
econornic efficiency consists not only in the exist- 
ence of superior methods of producing a supply 
but also in the fact that men want this supply. The 
average man of the twentieth century surpasses 
the average man of any previous age not less truly 
in his capacity to demand than in his capacity to 
supply. To this, all agencies for discovering and 
dis.seminating knowledge contribute. 

74, Finally, for that concentration of wants 
upon specific commodities which is essential to 
economic demand, there must exist the prospect of 
success in the effort to secure the commodities. For 
economic demand does not include all the wants 
that individuals might have for specific commodi- 
ties; it is limited to those wants which actually 
seek satisfaction. Under a simple form of organ- 
ization, where the steps in the process of satisfying 
wants lie within the control of a single individual, 
the prospect of success in the attempt to satisfy 
wants depends merely upon the individual's posses- 
sion of the necessary factors of production. The 
farmer can satisfy his want for food to the extent 
that he has the proper facilities for producing food 
and knows how^ to use them and is willing to make 
the requisite exertion. In other words, under these 
conditions, the ability to produce commodities and 
the ability to gratify wants are one and the same. 

With the introduction of division of function, 



160 THEORY OF ECONOMICS 

however, au individual and his possessions consti- 
tute but a part of the requisites for success in the 
effort to satisfy wants. Under such conditions, 
one's own efforts minister in part to his wants and 
in part to the wants of others; while others, in like 
manner, contribute to their wants and to his. In 
such a state of interdependence, one's prospect of 
success in the attempt to satisf}' his wants and, 
therefore, his effective demand, depend not only 
upon what he produces, but also upon what others 
produce and upon what they demand. In the first 
instance, the individual uses the means at his dis- 
posal to produce a supply of commodities, more or 
less with a view to meeting the wants of others. 
This, his contribution to supply, is at the same 
time a factor in his ability to secure the products of 
others, /. <?., in his effective demand for what others 
have produced for themselves and for him. The 
baker's bread, the miner's coal, the weaver's cloth 
and the cobbler's shoes are for each his supply and 
at the same time a condition of his effective demand. 
But the product of each is but one factor in his 
effective demand, for the demand of each is effective 
only when he has found some one who in turn de- 
mands his commodity. The miner is hungry and 
has a general want for food. He learns that bread 
will satisfj' this want and that a supply of bread is 
in the possession of the baker. The conditions of 
effective demand are met in part. There exists a 
general want and it has been specialized in so far as 
that requires a knowledge both that bread will sat- 



THE DEVELOPMENT OF DEMAND 161 

isfy the want and where bread can be found. But 
there ivS still something lacking. The miner offers 
his coal to the baker and finds that it meets the 
latter' s want for fuel, and then there exists in the 
full economic sense a demand for bread. In like 
manner, starting from the baker with his general 
want for fuel directed towards coal, and his supply 
of bread in excess of his own final want therefor, 
which the miner desires, there can be traced an eco- 
nomic demand for coal. 

The extensive use of a medium of exchange, 
which brings the consumer into relation with a 
middleman instead of with the original producers of 
commodities, obscures the interdependence of supply 
and demand. But a complete analysis of economic 
relations shows not only that a man's purchasing 
power is a necessary element in his demand, but 
that his purchasing power depends both upon his 
ability to produce something and also upon the 
adaptability of that which he produces to the wants 
of others and upon their demand for it. In no 
phase of the economic process is the mutuality of 
relations and the absolute necessity of unification of 
design to economic efficiency, more apparent. 

Moreover, to the extent that, through the de- 
velopment of division of function, ownership in the 
means for producing a complete commodity is no 
longer centered in one individual but is divided 
among several, one's effective demand is dependent 
also upon the distribution of wealth. For under 
such conditions, one's ability to purchase depends 



162 THEORY OF ECONOMICS 

upon what he receives in return for the services 
rendered \>y his factor or factors in the production 
of wealth. In the analysis of the economic proc- 
ess, it was found^ that when men cooperate for the 
production of wealth, its distribution among the 
parties thereto is essential to the realization of the 
end of that process. But distribution is important 
not onl)- because it is essential to the final satis- 
faction of wants, but also because it affects the 
efficiency of production, for upon the distribution 
of commodities depend the possessions of the indi- 
vidual and these influence the production both of 
supply and of demand. An efficient system of dis- 
tribution is indispensable to efficient production. 

1 \ 36. 



PART III 



DISTRIBUTION 



DISTRIBUTION 



75. Distribution, as a feature of the economic 
process, is concerned with the sharing of wealth by 
the members of society. The process of distribu- 
tion, as popularly understood, includes the trans- 
portation of commodities from place to place until 
they reach the final consumer, as when cotton grown 
in South Carolina is shipped to England, manu- 
factured into cloth, and then sent perhaps to China, 
where it is consumed. From the stand-point of 
economic theory, however, the transportation of 
commodities is a part of the process of production, 
which consists in getting commodities not only into 
the form but also into the place in which they are 
wanted. Distribution, on the other hand, is con- 
cerned with the amount of wealth that accrues to 
the various members of society. 

Distribution or the sharing of products arises 
from economic organization, in which, because 

Walker, Political Economy, \ 244 et seq. ; Gide, Political 
Economy, trans., Bk. IV.; Lauglilin, Elements of Political 
Econo}ny, chapter xvi.; Kly, Outlines of Economics, Bk. 11., 
Pt. III., chapter!.; Clark, The Distribution of Wealth. 

165 



166 THEORY OF ECONOMICS 

of division of function, the satisfaction of the 
wants of each calls for some of the commod- 
ities produced by others. Thus, when one man 
is a carpenter, another a farmer, another a 
tailor, and so on, it becomes necessary to share the 
results of the activities of each. Otherwise the 
satisfaction of wants would be hindered instead of 
promoted b}- division of function. If it were possi- 
ble for each to produce all that the satisfaction of 
his wants required, there would be no sharing of 
products among the members of society. It is, 
then, due to the existence of cooperation among 
men that it becomes necessary to distribute the out- 
put of the process of production. It belongs to 
distribution as a part of economic theor}- to describe 
the process of dividing the product and to di.scover 
and formulate the principles according to which 
the amounts of wealth which the various members 
of society receive, are determined. 

76. Certain conditions combine to give special im- 
portance to this feature of the economic process. 
An indi^ndual seeking to maintain life and to attain a 
higher development seeks that which will satisfy his 
wants, through which alone existence and progress 
are possible. To this end it does not sufl6ce merely 
that a large amount of commodities should be pro- 
duced. The satisfaction of one's wants depends 
upon the amount that he can apply to his own use. 
But, as a result of human nature, in which the 
capacity of want-development is indefinitely great, 
there are always some wants unsatisfied. Man is 



DISTRIBUTION 167 

always seeking more; and success in this effort de- 
pends upon one's abilit}^ to secure a larger portion 
in the distribution of wealth, w^hich maj^ or may 
not be accompanied hy a larger production of wealth. 
It is characteristic of much of the means for sat- 
isfying wants that its utilization by one involves 
its non-utilization by others. It is true that in a 
large number of instances, too often overlooked as 
of no importance to the economist or ignored as be- 
ing outside the scope of economic investigation, 
wants are of such a character that the use of com- 
modities to minister to one person interferes but 
little, if at all, with their use by others. To 
satisf}'- some of the aesthetic desires, one needs but 
to see or to hear. A beautiful picture or a song 
can minister to the wants of many at the same time. 
The wants to which the Sistine Madonna or Central 
Park ministers, are not necessarily less fully satis- 
fied because others are being served in like manner. 
On the other hand, many wants are preeminently 
exclusive, i. e., the commodities that minister to 
them can serve only one or a few persons. Ex- 
amples of these are found in nearly all of the com- 
modities that are required by the wants which arise 
from the physical nature of man, such as the want 
for food, for clothing and fuel. If a loaf of bread 
ministers to the hunger of one, it cannot minister 
to the same want in another. In this class, should 
be included also that most expansive and exclusive 
of all wants, the desire for private ownership. If the 
Sistine Madonna satisfied some one's want for it 



168 THEORY OF ECONOMICS 

merely to call it his own, its sphere of service might 
be very much narrowed. 

Commonplace as the facts of the expansibility 
of wants and the exclnsiveness of many, are, they 
deserve consideration, for they are potent causes 
of rivalry of interests among members of society. 
And rivalry of interests leads to serious problems. 
Indeed, most of the controversies that disturb 
society are tracealtlt- directly to one or both of 
these causes. The .^ocial problems are largely prob- 
lems of distribution. Herein may be found the 
principal occasion of the problems of labor, social- 
ism, money, banks, railroads, tariffs and trusts, as 
well as of others. And upon a correct understanding 
of the fundamental principles of distribution de- 
pends in large measure one's equipment for .solving 
these problems. 

77. The system of distribution prevailing at any 
time is the result of .social choice. That is to 
say, it is not an arrangement existing by virtue of 
certain physical laws independent of social will and 
regardless of the demand of social needs, but is 
the result of society's judgment, /. e., it is a 
method of dividing the output o{ the productive 
process among the members of society, which is 
established by societ}', presumably because the par- 
ticular system adopted is deemed best suited to pro- 
mote the general welfare. 

From the nature of the system of distribution as 
a creation of .society, it follows that, in common 
with all other social institutions, it is sul^ject to 



DISTRIBUTION 169 

change. Moreover, it may be accepted as inevita- 
ble that the system will be changed, whenever 
society believes that some other than the existing 
one will give a better distribution of its wealth. 
The essential nature of society compels it to seek 
the best method it can devise for satisfying its 
wants, and it is in accord with this principle that a 
new system or a modification of the old will follow 
inevitably when society is convinced that better 
want-satisfaction will result from such change. 

This fact should have a practical bearing in influ- 
encing the attitude of men toward propositions for 
modifying the existing methods of distribution. 
The tendency is very strong to accept the existing 
order, especially when one's immediate interests 
appear to be promoted by it, as of necessity perma- 
nent. This leads to a placid acquiescence in 
the bad as well as in the good in existing 
conditions with an attitude of helpless sub- 
mission to the decrees of blind fate. The 
ultimate result of such a policy may be such a 
congestion of evils as finally to destroy the barriers 
of conservatism and by the very impetuosity of 
radicalism, to lead to a new horde of evils. For it 
is the teaching of history that social institutions, 
so far from being permanent, are in a continual 
state of readjustment, and that to the extent that 
such readjustment is retarded beyond what is neces- 
sary to insure the utility of prospective changes, 
serious disorders follow. The histories of England 
and of France afford ample illustration of the differ- 



170 THEORY OF ECONOMICS 

ence between the results of social evolution and of 
social revolution. Experience teaches also that an 
individual may retard but can not prevent social 
readjustment, and the French Revolution stands as 
a permanent demonstration of the dangers involved 
in the undue postponement of the readjustment of 
social institutions to meet changes in social needs. 
But, though the system of distribution is a 
social institution and, therefore, subject to change, 
it is not, on the other hand, a mere arbitrary crea- 
tion. It is a development. It follows, then, that 
attempts to improve upon the existing order can 
succeed only when made with a due regard for the 
principles of development. This fact also has an 
important bearing upon the solution of the prob- 
lems arising out of distribution. It has been said 
that an individual may retard but he can not pre- 
vent social changes. It is equally true that an in- 
dividual may hasten a change but he cannot achieve 
an improvement in social conditions by that change 
merely because he intends an improvement. Prog- 
ress does not necessarily follow change, and the 
methods by which alone progress can be attained are 
not determined by the wishes of would-be reform- 
ers. Though men are in some degree free to choose 
whatever system of distribution they will, they can 
not escape the consequences of their choice. If a 
policy is adopted that is out of harmony with the 
conditions essential to progress, it will be .self- 
defeating. Thus, since the system of distribution 
sustains a vital relation to the process of production, 



DISTRIBUTION 171 

especially in its influence upon the incentive to 
activity, which so largely conditions productive 
efiiciency, and since the first requisite for distribu- 
tion is something to distribute, if a method of dis- 
tribution be adopted which impairs the efficiency of 
production, it will defeat the very end of distribu- 
tion by destroying the source from which the fund 
to be distributed is derived. 



THE BASIS OF DISTRIBUTION 



78. The fundamental characteristic of a system 
of distribution is the basis which serves as a cri- 
terion for determining the amount of product to 
which the parties to the distribution are entitled. 
In case men cooperate in some undertaking, they 
must adopt a basis for dividing the result 
thereof. For example, if several cooperate to raise 
a crop of corn, they must settle upon some basis of 
division. They may agree that each shall have 
the product raised on a definitely specified portion 
of land, or that each shall have a certain portion of 
the yield as measured in bushels, or that each shall 
receive a certain portion of the returns from the 
sale of the crop, or that the division shall be made 
in some other w^ay. But some basis of dinsion 
must be applied. Moreover, it is not a matter of 

Clark, The Distribution of Wealth, pp. 1-9, 36-51, et al.; 
Pantaleoni, Pure Economics, trans., Pt. Ill,, chapter i.; 
Gide, Political Ecoiiomy, trans., Bk. IV., Pt. I., chapter ii.; 
Sidgwick, Principles of Political Economy, Bk. II., chapter 
i. ; note also the basis of distribution involved in the theories 
of Walker, Ely, Mill and Laughlin. 



THE BASIS OF DISTRIBUTION 173 

indifLerence to the parties concerned, what basis of 
distribution is agreed upon. Some plans are more 
in accord with the sense of justice than others. 
Thus the method of dividing on the basis of the 
yield of specific portions of the land, though easily 
applied, is apt to be unsatisfactory, since it fails to 
take proper account of differences in the fertility of 
different parts of the soil. This method was largely 
employed in the old manorial system of mediaeval 
times, where for a given season each member of 
the community, serf and lord, was entitled to the 
yield from a definite portion of land. The disad- 
vantages arising from inequalities in the fertility of 
the soil Vv^ere in a measure offset by dividing the 
entire area to be cultivated into small strips and 
assigning these to the members of the manor in 
such a way that each man's holding consisted of 
small sections lying in different parts of the estate. 
Occasional redistribution of these strips tended to 
lessen still further the inequalities arising trom 
differences in fertility. But at best this method was 
open to criticism from the standpoint of justice, and 
with the development of permanent tenure in land- 
holding, it became entirely inapplicable. 

But however widely methods of distribution may 
differ in the character of their basic principle, all 
must have a basis, for it is indispensable to coopera- 
tion in the process of satisfying wants. Hence, 
society, which involves cooperation on the most ex- 
tensive scale, in establishing the principles of hu- 
man association, adopts certain bases according to 



174 THEORY OF ECONOMICS 

which its members shall share in the benefits accru- 
ing from such cooperation. The method of estab- 
lishing these bases is through the creation of rights. 
To discover the basis of distribution in society, 
then, it is necessary to consider the rights estab- 
lished, in their relation to the sharing in the wealth 
produced. 

79. The economic test of the sufiiciency of a 
basis of distribution is its effect upon the process of 
satisfying wants, for a system of distribution, in 
like manner with all other phases of the economic 
process, must be approved or condemned according 
as it promotes or impedes the attainment of the 
end of that process. Thus in primitive times, the 
basis of distribution was to a considerable extent, 
physical strength. So far as this prevailed, a man 
was considered entitled to what he could get and 
keep. But such a system of distribution involved 
a large expenditure of energ)^ for the protection of 
one's possessions, and in time more peaceful methods 
were substituted, through the widening of the scope 
of property and contract rights. The gain result- 
ing from the accompanying saving of energy showed 
itself in an increased economic efficienc)'. But 
though different bases of distribution may suit dif- 
ferent times and places, the ultimate test is the 
same. Does the system most efficiently promote 
the satisfaction of wants or is another system or 
some modification of the existing S3^stem, better 
suited to that end? 

80. Theoretically speaking, the bases of distri- 



THE BASIS OF DISTRIBUTION 175 

bution which might be adopted are numerous. 
Four only, however, require consideration. These 
m.ay be designated (1) equaHty, (2) need, (3) pro- 
duction and (4) value of services. 

Distribution on the basis of equality gives to the 
members of society equal shares of product. It is 
advocated by some who assert that all men are 
equal and are therefore entitled to equal portions of 
wealth. In actual practice, however, this theory 
finds but little application. It may, perhaps, be 
said to prevail in the distribution of rations 
among soldiers, in the allowances to inmates 
of penitentiaries and in the distribution of es- 
tates among heirs, in so far as the law provides 
for equal shares. But as a general basis on 
which to distribute the large fund of wealth 
among the members of society, it receives but little 
support. The reason is not difficult to discover. 
The basis is totalh^ incompatible with efficient pro- 
duction, as it seriously impairs the incentive to 
activity. An adequate incentive to activity requires 
that the prospect of reward should be seen in im- 
mediate relation to action. Distribution on the basis 
of equality would not only encourage rashness, by 
giving to him who fails the same reward as to him 
who succeeds, but it would also develop idleness, 
by giving to him who does not even try to produce, 
the same as to him who does. This basis is con- 
demned alike by the test of economic sufficiency and 
by the general sense of justice among men, which ac- 
cepts the doctrine that reaping should follow sowing. 



176 THEORY OF ECONOMICS 

81. The system of distribution on the basis of 
need, is suggested by its designation. It calls for 
the sharing of wealth by members of society accord- 
ing to their several needs rather than according to 
their several performances. Wants, not services, 
are taken as the basis of the right to share. Though 
not the prevailing principle of distribution, as so- 
ciety is now organized, it finds a limited applica- 
tion. The attempt is made to distribute charity on 
this basis, and it appears in substance wherever one 
is allowed to appropriate wealth to his own use 
without a compensation graded accordingly. Thus 
the post-oflfice charges a fixed amount for carrying 
a letter of a given size, and then convej^s it a long 
or a short distance according to the desire of the 
sender. A similar polic)^ prevails in the street- 
car service wherever a fixed charge is made regard- 
less of whether the passenger rides one block or 
many. This basis finds application also in the case 
of public streets, parks and schools, where the use 
allowed to the individual bears no relation to the 
size of his contribution thereto. 

But wherever this basis is applied, the reason 
therefor lies not so much, if at all, in consideration 
for the specific individual benefited, as in the re- 
quirement of the good of society as a whole, or of 
whatever agency is responsible for the adoption of 
the system. Not the right of the individual to be 
supported but the necessity of protecting society 
from the evils of pauperism, is the economic reason 
for charity; not the advantage to this or that indi- 



THE BASIS OF DISTRIBUTION 177 

vidual from parks or public schools, but the public 
good that is promoted by healthy, intelligent citi- 
zens, is the economic reason for public parks and 
public schools; not the obligation to the sender of 
a letter or to a passenger on a street-car, but the 
greater advantage to society or to the transportation 
company, is the economic reason for fixed charges 
and indefinite services in the post-office and street- 
railway. 

Though advocated for general adoption by 
some, who. propose that society shall exact "from 
every one according to his ability" and give "to 
ever}^ one according to his need," distribution 
according to need is limited by two serious obsta- 
cles. In the first place, as in the case of equal 
distribution, the distribution of product according 
to need, regardless of service, is opposed to a fund- 
amental requisite for efiicient production. So long 
as the reward which alone can give an adequate in- 
centive to activity, involves private ownership and 
use of the results of activity, a scheme which pro- 
poses to distribute according to need, thus reward- 
ing not only the weak and inefficient, but also the 
unwilling and indolent, cannot be otherwise than 
self-defeating, through its destructive effect upon 
production. Its inevitable tendency to perpetuate 
unfitness at the expense of fitness strikes at the 
very foundation of progress. 

A second obstacle to the application of this 
basis arises from the fact that w^ants exceed the 
means for satisfying them. In so far as the satis- 



178 THEORY OF ECONOMICS 

faction of the wants of one does not involve the 
impairment of the satisfaction of the wants of 
another, distribution according to need can be 
accomplished by leaving each to appropriate the 
means of want-satisfaction as he wishes. The 
larger number using the mail and street-cars under 
the present system makes it the most economic for 
for society. Within wide limits, the freedom of 
one to enjoy the advantages of public parks and 
public schools, not only does not interfere with the 
satisfaction of the wants of others, but actually 
increases their want-satisfaction, because it improves 
the quality of their associates. 

But in the presence of wants in excess of means 
for satisfying them, it cannot be left to each to ap- 
propriate according as he desires. The result would 
be a struggle so intense that many would be exter- 
minated and society would be turned back towards 
the primitive condition of savagery. When the 
means for satisfying wants are inadequate for the 
satisfaction of all wants, distribution on the basis 
of need could be proportionate onl5% Its applica- 
tion would result not in giving to each all that he 
needs, but in dividing the supply of commodities 
among the members of society in proportion to their 
needs. This would necessitate an estimate of needs 
and of supply, and the apportionment of the latter 
to the former. 

Needs are purely subjective phenomena, until 
they appear as wants for specific commodities. It 
is impossible to measure them except as they reveal 



THE BASIS OF DISTRIBUTION 179 

their relative intensity through individual choice, 
whereby one thing is preferred to another. Any 
other method of measuring needs would be purely 
arbitrary, the result of the judgment of some one 
other than the person having the need, in which 
case there would be absolutely no assurance that 
the resulting distribution would be proportionate to 
needs, and the ultimate effect v^^ould be nothing less 
than the surrender of personal freedom. But dis- 
tribution according to needs which are measured 
by an individual's choice between commodities, 
where the supply of commodities is inadequate to 
satisfy all wants, can be applied only by requiring 
one to give in return for what he receives and by 
allotting commodities to those who will give most 
for them ; and from this there results, not distribu- 
tion on the basis of needs, as that is understood by 
its advocates, but distribution on the basis of value, 
jand this, as will be seen later, is the method pre- 
vailing under the present industrial organization. 

An analysis, then, of the nature and re- 
quirements of distribution according to needs 
shows, on the one hand, that its application is 
possible only when that which is to be distributed is 
of such a nature that its appropriation by one will 
not lessen the satisfaction of the wants of others. 
For only under such conditions can the principle 
work spontaneously, by leaving each free to appro- 
priate as he wishes, thereby avoiding the necessity 
of an arbitrary apportionment of product among 
members of society, an alternative which is itself 



180 THEORY OF ECONOMICS 

incompatible with the system. The analysis shows, 
on the other hand, that the principle of distribution 
according to needs, even if possible, is feasible only 
when conditions are such that it can be applied 
without endangering the efficiency of production 
through its tendency to impair the incentive to 
activit5^ 

Under these circumstances, it is, to say the least, 
extremely doubtful whether conditions can ever 
exist which will justif}^ anything like a general 
adoption of this basis as the predominent method 
of dividing product. There are, however, some 
reasons for believing that the basis may attain a 
much wider application than it does at present. The 
most serious obstacle to its working is the preva- 
lence of exclusive wants. And though present 
business methods do not seem to afford much ground 
for anticipating a large predominence of non-exclu- 
sive wants, in the near future, their spread is more 
extensive and rapid than a casual view reveals. 
The growing tendencj?- of men of wealth to endow 
public institutions and the disposition of municipali- 
ties to undertake the establishment of parks and 
other enterprises, the enjoyment of which may be 
appropriated freely, are essentially an increase in 
the application of distribution according to need. 
Moreover, it is by no means impossible that when 
the progress of discovery in the realm of the physi- 
cal world shall have further lightened the burden of 
maintaining existence, and when a higher intelli- 
gence shall control men's views of life, a far wider 



THE BASIS OF DISTRIBUTION 181 

field for the operation of this basis will be opened. 
The desire for private ownership, which is now the 
mainspring of economic activity, and is preemi- 
nently an exclusive want, may then yield its su- 
premacy as an incentive to activity, to a desire for 
spiritual growth. Under such conditions, greater 
community of participation in the means for satisfy- 
ing wants will be possible and will be desired by 
the members of society. Even here, however, the 
application of the basis will be possible only in the 
case of such means for satisfying wants as can, 
without injury to society, be thrown open to appro- 
priation by men either without direct return there- 
for, or with a return that is not adjusted in size to 
the amount received. 

82. A third basis proposed for distribution is that 
wealth shall be apportioned among the mem- 
bers of society according to the amount contributed 
by each to the production of wealth. This is some- 
times called distribution according to service, but 
such a designation of this basis should be qualified 
by adding that the service is to be determined by 
measuring the amount of each one' s contribution to 
production. But the question arises, how is one's 
contribution to production to be determined ? Some 
answer, by ascertaining the amount of labor ex- 
pended, on the ground that wealth is the product 
solely of labor. But there are few, if any, more 
fallacious propositions than that which holds that 
wealth is due to labor alone. Ivabor, unaided by 
the other factors of production, is absolutely help- 



182 THE OR i ^ OF ECONOMICS 

less and can produce no wealth. Even if enterprise 
be considered an element of labor, it still remains 
true that labor without capital and situation is as 
helpless in the production of wealth, as are capital 
and situation without labor. To distribute on the 
basis of contribution to production, it is necessary 
to ascertain the amount contributed b)^ each of the 
factors, in order that the owners thereof may re- 
ceive in proportion thereto. 

It is sometimes assumed that the contribution of 
the several factors can be determined by ascertain- 
ing the difference between the amounts produced 
before and after the addition of a unit of each to 
the productive operation. Thus, if, after adding 
ten laborers to the force engaged in manufacturing 
shoes, the output is increased by ten pairs of shoes, 
it is inferred that ten pairs of shoes represent 
what the ten men have produced. The conclusion 
seems plausible, but it is fallacious. Suppose five 
men attempt to lift an iron rail but find that they 
cannot accomplish it. Two more men are added 
and the rail is lifted. The method of determin- 
ing the contribution to production described, would 
be compelled to assign to the two men last added 
the entire credit for lifting the rail, since this rep- 
resents the difference between what was accom- 
plished before and after the addition of the two 
men. The fallacy is here apparent. The addition 
of the two men increased the efficiency of the entire 
process. The same is true of the addition of the ten 
men to the shoe factory. While it is possible to 



THE BASIS OF DISTRIBUTION 183 

measure the total efficiency of the productive oper- 
ation, and the increase in total efficiency which fol- 
lows the application of additional amounts of one 
or more of the factors, it is impossible to measure 
the amount actually produced by any one factor or 
by any unit of a factor. 

Moreover, the production of wealth does not con- 
sist merely in the production of a supply of com- 
modities; it consists in the production of value. 
And for value there must be both supply and de- 
mand. Even if it were possible, then, to measure 
the contribution of a factor to the production of 
supply, this would not give the contribution of that 
factor to the production of value, for the same con- 
tribution to the production of supply will give dif- 
ferent values under different conditions of demand 
for that supply. Thus, the same contribution to 
the production of wheat which at one time gave 
1,000 bushels, each worth $1.00, may at another 
time give 1,000 bushels which by reason of in- 
creased demand for wheat will be worth $1.50 per 
bushel. To whom will this increased value go? 
That depends upon the relation of the supply of 
and the demand for the several factors. If, for ex- 
ample, the supply of situation is more limited rela- 
tive to the demand for it than is the case with the 
other factors, the increase in value will tend to go 
to the owner of situation, not because situation has 
contributed more to the production of the value of 
the wheat, but because the value of the services of 
situation has increased. 



184 THEORY OF ECONOMICS 

83. Under the existing industrial organization, 
the shares of members of society are determined, 
with few exceptions, by the value of the services of 
one or more of the factors of production owned by 
them. To the extent that the factors employed in 
any productive operation are owned by one man, 
the value of their services is determined indirectly 
through the sale of the commodity produced. Thus 
the share of the weaver who owns his plant and 
raw materials, weaves the cloth and places it on 
the market as his own, is determined through the 
sale of that product. But in so far as differentia- 
tion in the ownership of the factors has resulted in 
their emplo5^ment for production by others than 
their immediate owners, the value of the services of 
the factors and the shares received therefor are de- 
termined through the sale of the services them- 
selves. Thus the shares received by the owners of 
situation, capital and labor, when those factors are 
utilized for production by the entrepreneur, are de- 
termined by the sale of the services of those factors. 
To understand the system of distribution, then, it 
is necessary to ascertain the principles which oper- 
ate in the process of bu54ng and selling. 



EXCHANGE 



84. The distribution of product among mem- 
bers of society is accomplislied largely through 
the operation of buying and selling. Individ- 
uals produce for others as well as for them- 
selves, in the expectation that by selling their 
own products they can secure some of that 
which is produced by others. On this plan the 
share of each member of society, where division of 
function exists, consists of that portion of his prod- 
uct, if any, which he retains for his own use, and 

Walker, Political Economy, Pt. III., chapters i., iii.; 
Laughlin, Elements of Political Economy, Bk. II.; Gide, 
Political Economy, trans., Bk. II., Pt. II., chapter iii.; 
Pantaleoni, Pure Economics, trans., Pt. II.; Ely, Outlines 
of Economics, Bk. II., Pt. II., chapters ii.-v. ; Monopolies 
and Trusts, chapters iii., iv. ; Jenks, The Trust Problem; 
Von Wieser, Natural Value, trans., Bk. II.; Bohm-Bawerk, 
Positive Theory of Capital, trans., Bk. IV.; Roscher, Polit- 
ical Economy, trans., Bk. II., chapter ii.; Mill, Principles 
of Political Economy, Bk. III.; Sidgwick, Principles of 
Political Economy, Bk. II., chapters ii., x.; Marshall, Prin- 
ciples of Economics, Bk, V.; Jevons, Theory of Political 
Economy, chapter iv. ; Clark, The Distribution of Wealth, 
see index. 

185 



186 THEORY OF ECONOMICS 

of that portion of the product of others which 
he secures. For example, the farmer may reserve 
some of his wheat for his own consumption and 
with the balance obtain some of that which 
the weaver, the grocer, the carpenter and others 
have produced. Or if the nature of the com- 
modity is such that it is adapted to final con- 
sumption only after it has passed through one or 
more processes carried on by others, he who pro- 
duces it, will expect to sell all of it. Such is the 
case when the individual confines himself to raising 
cotton or other raw materials. Here the individual's 
share of product consists entirely of what he secures 
from others. 

From the extensive application of division of 
function in modern society, it has resulted that 
a very considerable portion of the effort to satisfy 
wants is concerned with the operation of buying 
and selling. Considered as a phase of the economic 
process, this is called exchange, and is defined to 
consist of the transfer of ownership in wealth, or 
in the use of wealth. But though this is the imme- 
diate object of buying and selling, the real sig- 
nificance of exchange as a feature of economic 
activity arises from its relation to the distribu- 
tion of product among members of society. 
Through the complicated and apparently con- 
fused mass of transactions concerned with buy- 
ing and selling, with markets and with all that is 
related to the transfer of ownership, there is in proc- 
ess of determination the amount of total product 



EXCHANGE 187 

which each member of society receives. And from 
this it follows that upon the existence of the condi- 
tions necessary to exchange and upon the terms of 
the exchanges effected will depend the character of 
distribution and the efhcienc5^ of the economic 
process, to the extent that this is dependent upon 
distribution. 

85. The conditions which must exist in order 
that exchange should take place are not difficult to 
ascertain. If an exchange of commodities is possi- 
ble, it will occur when each of two parties desires a 
commodity possessed by the other more than that 
possessed by himself. Thus, if one man, who owns a 
horse, prefers a certain piece of land to the horse, 
and the owner of that piece of land prefers the 
horse to the land, they wall exchange. Such a 
condition as this has been called a double coinci- 
dence of desires, and when this exists an exchange 
follows, provided the nature of the commodities 
and the other circumstances involved permit of an 
exchange. 

Carrying the analysis one step further, it ap- 
pears that two conditions are essential to the 
existence of a double coincidence of desires. In 
the first place, it is necessary that the character of 
the commodity possessed by each, as regards its 
general nature, its quality and its available quan- 
tit5^ should be such as to meet the desires of the 
other party; in the second place, it is necessary that 
the two parties should agree as to the rate of 
exchange, z. <?., as to the relative amounts of want- 



188 THEORY OF ECONOMICS 

attracting power possessed by each commodity, — 
in short, they must agree as to the price. Thus, in 
the illustration given, an exchange between the 
owner of the horse and the owner of the land 
would not take place if the character of the horse or 
of the land did not suit the would-be purchaser; 
nor would there be an exchange if the owners did 
not agree as to the relative values of the horse and 
of the land, even though the one desired a piece of 
land more than his horse and the other preferred 
a horse to his piece of land. 

86. The fulfillment of the first of these condi- 
tions depends primarily upon the accurac}' with 
which individuals in producing with a view to meet- 
ing the wants of others, forecast those wants and 
adjust their production thereto. But it may hap- 
pen that, even when the commodities produced 
are desired, an exchange will be prevented through 
an absence of the necessary coincidence of desires. 
To illustrate, one person. A, with meat to sell, may 
desire clothing; another, B, with clothing to sell, 
may desire fuel; a third, C, with fuel to sell, may 
desire meat. As the case stands, there does not 
exist the double coincidence of desires necessary to 
effect an exchange. But if the owner of meat, A, 
knows that C, who has fuel to sell, wants meat, 
while B, who has clothing to sell, wants fuel, A 
may exchange his meat with C for fuel, and then 
exchange this with B for clothing. Fuel becomes 
to A the medium through which a double coinci- 
dence of desires is established, first between him- 



EXCHANGE 189 

self and C, and then between himself and B. This 
is typical of a condition that often arises in mod- 
ern industrial society, where it is seldom that both 
of the parties to an exchange have final desires for 
the commodit}^ possessed by the other. As in the 
illustration, the obstacle to an exchange that would 
otherwise exist, is commonl}^ removed by the use of 
a medium of exchange. 

The essential function of a medium of exchange 
is to suppl)^ a double coincidence of desires. In 
order that a thing should perform this function it 
must possess such characteristics as will enable the 
person receiving it to secure that which he 
desires through its use. Or, to state this as a 
general principle, to serve as a medium of 
exchange, a thing must possess the power to 
command property in commodities. The reason 
is obvious. An individual is willing to ex- 
change his commodity for something which he 
does not desire for itself, provided it will en- 
able him to secure that which he does so desire. 
Out of the use of a medium of exchange arise 
numerous questions as to the best way to supply it. 
From various causes, it may vary in its power to 
command property in commodities, /. <?. , in its pur- 
chasing power, and such variations affect vitally 
the shares received by members of society. For 
the present discussion, however, it sufiices (1) to 
describe the function of a medium of exchange in 
the general economic process, which consists in 
facilitating the operation of buying and selling by 



190 ' THEORY OF ECONOMICS 

assisting to secure a double coincidence of desires 
and (2) to state the requisite for performing that 
function, which is the possession of power to com- 
mand property in commodities. 

Another method of obviating the difficulties 
involved in securing a double coincidence of desires, 
is by the use of credit, though an exchange on the 
basis of credit is, in reality, an incomplete ex- 
change. In modern business, as has already been 
pointed out, credit has become an important factor 
in the process of transferring ownership in com- 
modities; according to conservative estimates, from 
80 to 90 per cent, of the entire volume of trade is 
carried on by its use. Under such circumstances 
the conditions essential to the maintenance of credit 
become of the highest importance. 

In a well ordered society, whose legal machinery 
provides adequate facilities for the enforcement of 
contracts, the most important requisite for efl&cient 
credit is stability in the value of that which soci- 
ety establishes as a legal tender, i. e., that whose 
payment societ}'' recognizes as a fulfillment of the 
obligation involved in a contract. For instability 
in the value of the legal tender introduces uncer- 
tainty as to the ultimate result of credit transactions 
and invariably leads to a contraction of the use of 
credit. If the value of the legal tender increases, debt- 
ors are obliged to give in payment of obligations a 
greater amount than was contemplated when the 
contracts were made; and if the value of the legal 
tender decreases, there is an opposite result, the 



EXCHANGE 191 

debtor becomes able to meet his obligations with 
less value than was contemplated. In the former 
case the creditor gains at the expense of the debtor; 
and in the latter case, the debtor gains at the 
expense of the creditor, both of which results seri- 
ously impair the efhciency of the economic process. 

87. But even though the commodity possessed 
by each of two parties suits the other so far as its 
character is concerned, an exchange will not take 
place unless an agreement is reached as to the rela- 
tive values of the two commodities, i. e., as to the 
price of each. An agreement by two parties as to 
the price in a proposed exchange of commodities 
depends upon the status of the alternatives that are 
available to each ; for, in deciding upon the ques- 
tion of price, preliminary to an exchange, the mat- 
ter presents itself to each of the parties as a choice 
between alternatives. Each may either (1) accept 
the estimate of the relative values of the commod- 
ities made by the other, or (2) seek an exchange 
with someone else offering more favorable terms, or 
(3) retain his commodity for his own use. 

The availability and desirability of these alterna- 
tives depend upon a variety of conditions. As 
division of function increases, thereby limiting the 
range of each one's operations within narrower 
bounds, the availability of the third alternative, 
i. e., the use of one's commodity by himself, 
diminishes, for the supply of that which each pro- 
duces tends to exceed what he requires for his own 
use. If the character of the commodity is such as 



192 THEORY OF ECONOMICS 

to necessitate further manufacture to fit it for final 
consumption, or if its durability is so limited as to 
require its immediate use, the disposition to accept 
almost any terms rather than not exchange will be 
very great. Indeed, if the commodity is not one 
that ministers to life, and its exchange is the only 
way by which its owner can obtain the necessities 
of life, the pressure to exchange becomes practi- 
cally compulsion, and the proposed terms must be 
accepted or others found that are better. The avail- 
ability of the second alternative depends upon 
whether another party can be found who places a 
relatively lower estimate upon the value of his com- 
modity. This is but to say, in substance, that the 
availability of the second alternative depends upon 
the supply of and the demand for the commodities 
concerned. Indeed, the entire problem of the 
availability and desirability of alternatives in ex- 
change rests upon the supply of and the demand 
for commodities. The question is primarily one of 
value. 

88. The status of alternatives in exchange is of 
the highest importance in distribution. As has 
been said, they determine in part whether in any 
given case a prospective exchange of commodities 
will actually take place. But more than this, they 
determine largely the effect of exchange upon the 
distribution of wealth; for upon the alternatives 
available depends the price at which commodities 
exchange and upon the price received depends the 
effect of an exchange upon the shares of the par- 



EXCHANGE 193 

ties thereto. An exchange at a relatively high 
price means to the seller a large share and to the 
purchaser a correspondingly small share of the 
commodities exchanged; while an exchange at a 
relatively low price means exactly the opposite, to 
the seller a small share and to the purchaser a cor- 
respondingl}^ large share of the commodities ex- 
changed. One's share of product, then, in so far 
as it is received through exchange, depends upon 
his ability to control the alternatives in connection 
with exchange. 

To the extent that one receives a part or all 
of his share through an exchange of commodities, 
the size of his share is determined by (1) the 
amount of commodities sold, and (2) the price ob- 
tained; for, other things being equal, the larger 
the amount of one's sales and the higher the price, 
the larger is the share received in the distribution 
of wealth. It follows, then, that the problem pre- 
sented to every man in offering his commodities for 
sale, is how to sell as much as possible at the high- 
est price possible. But the amount of sales and the 
price obtained sustain a vital relation to each other. 
The lower the price of the commodit}^, i. <?. , the 
smaller the amount of other commodities demanded 
in return for it, the larger will be the number of 
those willing to exchange. This is the meaning of 
the common statement, "the lower the price, the 
greater the demand," i. e., the lower the price, the 
larger is the number of those whose want is suffi- 
ciently intense to induce them to give the amount 



194 THEORY OF ECONOMICS 

of their own commodity necessary to effect an ex- 
change. On the other hand, the lower the price, 
the smaller is the amount of product received as 
the result of a given exchange. The efforts of in- 
dividuals in exchanging commodities are, therefore, 
directed towards securing the largest extent of sales 
and the highest price which together will give the 
largest net returns. 

89. If one would extend his sales, he must offer 
better alternatives than are available elsewhere. To 
do this, he must lower the price of his commodity, 
or, what amounts to the same thing, give a better 
article for the same price. For, so far as the pur- 
chaser is concerned, the lower the price, the more 
advantageous is the exchange, and in seeking to 
expend his energy for the satisfaction of his wants 
in the direction of least resistance, he seeks to pur- 
chase at the lowest price. To the purchaser, as has 
been seen, the question is one of alternatives ; and 
the more advantageous the alternative offered by 
any one, the larger will be the number of pur- 
chasers. 

To the extent that alternatives are available at 
any time, there exists rivalr}' of interests among 
those offering them. To the seller, the existence 
or rival alternatives presents an obstacle to the sat- 
isfaction of his wants, and his effort to overcome 
that obstacle, which leads to a lowering of the 
price, is competition.^ 

1 Cf . § 32. 



EXCHANGE 195 

The degree of rivalry existing and the intensity 
of the competition vary, because the availabihty of 
the alternatives varies. The more nearly commod- 
ities resemble each other and appeal to the same 
want, the more intense will be the competi- 
tion. Thus competition between sellers of wheat 
will be more intense than between sellers of wheat 
and sellers of meat, but since a purchase of either 
one of these two commodities may prevent a pur- 
chase of the other, there is some competition be- 
tween those offering them for sale. In like man- 
ner, though in different degrees, there is competi- 
tion between both the sellers of wheat and of meat, 
on the one hand, and the sellers of books, on the 
other. Wheat and meat being food products, 
the competition between different sellers of wheat 
or of meat, or between the sellers of wheat 
and of meat, will be more intense than the 
competition between the sellers of those com- 
modities and the sellers of books. But since 
a purchase of wheat or of meat may prevent 
a purchase of books, and, vice versa, a purchase of 
books may prevent a purchase of wheat or of meat, 
there is some competition, not only between farm- 
ers, and between farmers and butchers, but also 
between farmers and butchers, on the one hand, 
and book-sellers, on the other. The extent of com- 
petition depends upon the amount and character of 
the existing alternatives. Some competition, however, 
is present arid effective to the extent that any alter- 
native is available. 



196 THEORY OF ECONOMICS 

The effect of competition bet^Yeell sellers is 
to lower prices. The extent to which competition 
will be carried and prices lowered, depends upon 
the nature of the interests involved. It will cease 
normally when price reaches the lowest point that 
will suffice to induce the production of the com- 
modit)', for at that point alternatives tend to be 
withdrawn. If a fair return above the expense of 
production be included in cost of production, 
cost of production may be said to determine the 
normal limit to downward movements in price. To 
carr}' price lower than this would result in a loss, 
and rather than submit to that an individual will 
transfer his attention to the production of some 
other commodity which seems to offer better pros- 
pects of reward. Here, then, is the relation sus- 
tained by cost of production to value. It is not 
the basis of value, but through price, which is value 
expressed in terms of a measure, cost of production 
sets a limit below which value will not normally 
fall. 

But competition maj' force price below the 
normal limit. In the case of the so-called perma- 
nent investments, as of fixed capital in a railroad 
and other similar enterprises, the transfer of which 
to other industries is difficult or impossible, compe- 
tition ma}" force price down to a point where the 
returns but little more than suffice to pay the cur- 
rent expenses of operating the business. For con- 
ditions ma}' arise in which the choice lies between 
such small returns and nothing at all. Indeed, 



EXCHANGE 197 

hoping for better conditions in the future, price 
ma}' fall temporarily even lower than this. But 
competition that drives price lower than cost of 
production cannot be permanent. For, as has been 
said, investments will cease to be made in an indus- 
try where such conditions arise ; when, therefore, 
existing facilities for production along such lines 
are exhausted, the former supply of alternatives 
will no longer be provided and competition will de- 
crease. Still, the character of the industry may be 
such that much time must elapse before present 
facilities are exhausted, hence the competition that 
carries price below the limit of profitable industry 
may be long continued and work great injury to 
economic interests in general. 

90. The extent of the individual's sales, then, 
depends upon his ability to offer through lower 
prices, more advantageous terms than can be 
secured elsewhere, and so long as other alternatives 
are available, competition forces prices down. But 
one's share in product may sometimes be increased 
in another way, /. e. , through raising the price of 
the commodity offered for sale. Moreover, the 
same impulse that leads one in general to seek the 
maximum of want-satisfaction, will lead the seller 
of a commodity to increase the price thereof, pro- 
vided, by so doing, he can increase his share of 
wealth. 

The availability of this method of increasing 
one's share depends upon the ability to control the 
supply of the means for want-satisfaction, for in so 



198 THEORY OF ECONOMICS 

far as one controls the supply of that which is 
required to satisfy wants, he lessens the pur- 
chaser's abilit)^ to avail himself of another alter- 
native and is thereby enabled to fix the terms 
of exchange. Such power of control on the part 
of the seller in his contest with the purchaser over 
the terms of exchange, is monopolization.^ 

As with competition, monopolization varies in 
effectiveness with the nature of the commodity 
concerned-. The more nearly commodities minister 
to the same want, the greater is the necessity of 
controlling the supply of all of them, if prices are to 
be raised. Thus gas, electric light, oil and candles, 
all minister to the desire for light. Of these, 
gas and electric light probably minister more 
nearly to the same want than does any other com- 
bination of them; while gas, electric light and oil 
are much preferred to candles for general lighting 
purposes. The control of the suppl}^ of gas, electric 
light and oil would give their possessor more power 
to increase his share by increasing price than would 
control over gas, electric light and candles, or over 
any other combination of these commodities. The 
degree of monopolization depends upon the amount 
of control over the possible alternatives. So7ne 
mo7iopolization, however, is present and effective to 
the extent that any such control exists. 

The effect of monopolization on exchange is to 
raise prices. It is sometimes said that monopoli- 

' Cf. I 32. 



EXCHANGE 199 

zation lowers prices, and instances are cited, where 
the growth of large industries has resulted in reduc- 
tion in price. But to the extent that individuals 
seek the maximum satisfaction of their wants, every 
instance of a fall in price will be found due to the 
existence of competition, arising from the fact that 
alternatives are available which might be preferred 
but for the lowering of price. The view that monop- 
olization lowers price rests upon a mistaken idea of 
what monopolization realty is. Monopolization is 
not mere power of control over commodities ; it is 
power of control in its relation to rivals. The de- 
gree of monopolization is influenced but not deter- 
mined b}'^ the absolute amount of commodities con- 
trolled. If six persons were on an island without 
the means of communication with other places, and 
with only one box of biscuits for food, the posses- 
sion of that supply of biscuits would give its 
owner an immense power of control over the con- 
ditions of their sale. But ownership of the 
same amount of biscuits in a country where 
others were available and where supplies of other 
kinds of food were abundant, would give their 
possessor but a slight control over the conditions 
of their sale. The degrees of monopolization given 
by ownership of the same amounts of supply are 
vastly different in the two cases. In the former 
case, monopolization approaches as near the abso- 
lute as can be conceived; in the latter, it is too 
small to be recognized except for scientific purposes. 
On the other hand, control over a large amount of 



200 THEORY OF ECONOMICS 

commodities does not necessarily result in a high 
degree of monopolization, for monopolization is a 
matter of abilit}^ to control the conditions of want- 
satisfaction in the presence of rival interests, and 
the absolute amount of commodities controlled 
affects it only as it affects that power of control. 

Monopolization as well as competition has a 
normal limit beyond which, even if there exists 
power to raise prices, it will not be exercised. This 
normal limit is the point beyond which the induce- 
ment of purchasers to produce their commodities, 
is destroyed. That point is the cost of producing 
those commodities. Hence the normal limit to up- 
ward movements in the price of any commodity is 
the cost of producing other commodities which are 
to be given in exchange. For to carry price beyond 
this point involves an impairment of productive 
efficiency and, therefore, ultimately, the defeat of 
the end for which prices are raised, /. e., want- 
satisfaction. 

But though a normal limit is thus set to upward 
movements in price, it is by no means certain that, 
in any given case, the increase will cease when price 
reaches that point. Conditions may be such that 
those possessing the power of control will not be 
directly and immediately affected by the evils of 
excessive prices. Under such circumstances, ignor- 
ance of the ultimate effects of their actions or an 
absence of concern for the social welfare in -general, 
may delay the working of the remedy for excessive 
prices which inheres in their effect upon production, 
and result in much damagre. 



EXCHANGE 201 

91. From the foregoing analysis of the conditions 
determining the increase and decrease of prices, there 
follows the law of price: the price of a commodity in 
exchange is the resultant of the influence of competi- 
tion and monopolizatio7i, falliyig as competition pre- 
vails and risi7ig as monopolization prevails. 

The normal limit to the downward movement 
in the price of any commodity is its cost of pro- 
duction, because the disposition of producers to 
cease providing a supply of commodities when price 
reaches that point, by lessening the availability of 
alternatives, gives to those still offering the com- 
modity for sale an increased power to control price. 
In other words, in the contest between competitive 
and monopolistic influences, the latter tends to pre- 
vail and to prevent further reduction in price when 
price falls to cost of production. 

The normal limit to upward movements in price 
is the cost of producing other commodities which 
are to be given in exchange, because above that 
point the alternative of ceasing to produce those 
other commodities for exchange becomes preferable 
to the terms of exchange offered. In other words, 
in the contest between the competitive and monop- 
olistic influences, the former tend to prevail over the 
latter and to prevent further increase in price, when 
price reaches a point where more is required of the 
purchaser than the cost of producing the commod- 
ities he can offer in exchange. 

92. Thus far the analysis of exchange has 
viewed the operation from the standpoint of a 



202 THEORY OF ECONOMICS 

seller and his relation to a purchaser. There are, 
however, two parties to every exchange, and the 
conditions attending the action of one have an 
inevitable effect upon the other. Hence, so long 
as but one of the parties to an exchange and his 
commodity are considered, the analysis is incom- 
plete. It should be obser^^ed, however, that the 
inadequacy of such an analysis does not arise from 
the fact that it views an exchange from the stand- 
point of the seller rather than from that of the 
purchaser, but from the fact that it considers the 
matter from the standpoint of but one of the sellers. 
So far as an individual's attitude of mind is con- 
cerned, buying and selling may differ, but as eco- 
nomic phenomena they are opposite ways of look- 
ing at the same act. He who is seeking to buy to 
the best advantage is seeking also to sell to the 
best advantage that which he offers in exchange. 
To complete the analysis, then, it is necessary to 
consider the effects of an exchange in relation to 
both of the parties thereto. 

When the price of a commodity falls, the price 
of the commodity offered in exchange by the 
purchaser of the first commodity rises, and vice 
versa. Thus if one bushel of wheat is exchanged 
for five pounds of meat, the price of one bushel of 
wheat is five pounds of meat, and the price of one 
pound of meat is one-fifth of a bushel of wheat. 
If, now, because others offer more advantageous 
terms, it becomes necessary to give two bushels of 
wheat for five pounds of meat, the price of wheat 



EXCHANGE 203 

falls ; the price of a bushel of wheat becomes two 
and one-half pounds of meat. But this involves a 
rise in the price of meat, the price of one pound of 
which becomes two-fifths of a bushel of wheat. In 
other words, the competition between the owner of 
wheat and his rivals has increased the control of 
the owner of meat over the price of his commodity. 
But this indicates a greater degree of monopoliza- 
tion on the part of the owner of meat, for the power 
of control which results from the weakness of 
others is as truly monopolization as the power of 
control that results from adding to one's own 
strength. Competition, then, between rivals in the 
selling of commodities is one of the methods by 
which the purchasers thereof increase their monopo- 
lization in the sale of the commodities which they 
offer in exchange. 

On the other hand, if the owner of wheat can so 
far control the supply of wheat and its rival 
commodities that he can compel the owner of meat 
to give ten pounds of meat for one bushel of wheat, 
the price of one bushel of wheat becomes ten pounds 
of meat, and the price of one pound of meat be- 
comes one-tenth of a bushel of wheat. This means 
that monopolization by the sellers of wheat and 
its rival commodities has increased the intensity 
of the rivalry against which the owner of 
meat is obliged to contend, that is to say, 
it has increased the competition he has to meet. 
Monopolization by the sellers of a commodity is, 
then, one of the methods by which the com- 



204 THEORY OF ECONOMICS 

petition to which purchasers are subject in the sale 
of their commodities, is increased. Competition 
and monopohzation in their relation to the ex- 
change of commodities are opposing and insepara- 
ble manifestations of economic activity.^ 

93. The fact that an increase in the price of one 
commodity in an exchange involves a decrease in 
the price of the other commodity, and vice versa, 
has an important bearing also upon the relation of 
the shares of the parties concerned to each other. 
The immediate effect of a movement in price is to 
increase the share of one and to decrease the share 
of another. Thus, if the price of one bushel of 
wheat is five pounds of meat, an exchange on that 
basis results in one man parting with one bushel of 
wheat and receiving five pounds of meat, while the 
other parts with five pounds of meat and receives 
one bushel of wheat. But if the price of one bushel 
of wheat increases to ten pounds of meat, an ex- 
change gives to the man who parts with one bushel 
of wheat, ten pounds of meat, while he who parts 
with five pounds of meat receives but one-half a 
bushel of wheat. 

The advantages or disadvantages resulting to 
one through a change in the prices of commod- 
ities may be offset in the end wholly or partly 
by the subsequent effect of that change upon 
the other party. Thus if an increase in the 
price of a commodity so far diminishes the 

^Cf. ?33. 



EXCHANGE 205 

amount received by the purchaser thereof, as to 
decrease his productive efficiency, the first party 
to the exchange ma)'- suffer as a result of diminished 
production. On the other hand, the disadvantage 
resulting to one through a decrease in price may be 
offset by an increase in sales, or by the increased 
productivity of the other party to the exchange, 
who, now that he receives a larger return, may feel 
an increased inducement to act. But whether these 
changes in production affect him who gains or loses 
b}'^ a rise or fall in the price of his commodity, de- 
pends upon whether subsequent exchanges diminish 
or increase his share. 

From the relation of the terms of exchange 
to the shares received by the parties thereto, it fol- 
lows that, in any given case, exchange, or as it ts 
often designated, trade, is not necessarily of equal 
advantage to both parties. Indeed, although un- 
der the circumstances existing at the time, each of 
the parties to an exchange must receive, or think 
that he will receive, some benefit, otherwise the 
exchange would not take place; still, if the ex- 
change results in giving to either of the parties less 
than was expended by him in production, or less 
than he might have received had the division of 
function which gave rise to the exchange, not taken 
place, the ultimate result of the operation is to that 
part}^ a loss. 

The relative distribution of benefits in an ex- 
change depends entirely upon the relative degrees 
to which competition and monopolization prevail in 



206 THEORY OF ECONOMICS 

connection with the respective parties. To the ex- 
tent that one is subject to competition in determin- 
ing the conditions of exchange, his share decreases, 
and the share of the other party increases, at least 
until competition shall have gone so far as to impair 
productive efficienc}-. On the other hand, to the ex- 
tent that one can avail himself of monopolization, 
his share increases, while the share of the other 
party decreases, until excessive monopolization im- 
pairs production. Healthy trade depends upon a 
proper balancing of the competitive and monopolistic 
infiiiences. 

94. The analysis of the effect of price on the 
shares received by individuals has been illustrated 
by cases in which exchange is made without the use 
of a medium of exchange. The employment of a 
medium of exchange, however, though affecting 
materially the extent to which exchanges take 
place, in no way alters the fundamental principles 
involved. The advantage of analyzing exchange 
as it proceeds in the absence of a medium of ex- 
change lies in the fact that certain concepts associ- 
ated with a medium of exchange tend to obscure 
the essential character of the process. In the lan- 
guage of the market, selling is usually thought of 
as an exchange of some general commodity for a 
medium of exchange, or monej' as it is com- 
monly called. Hence, in selling wheat, for exam- 
ple, it does not appear that one man sells wheat and 
buys a medium of exchange, — gold, silver, copper, 
paper or whatever serves that purpose, — while the 



EXCHANGE 207 

other sells the medium of exchange and buys 
wheat. Yet such is the case, and failure to recog- 
nize the fact leads to erroneous ideas as to the func- 
tion of a medium of exchange. There may be and 
usually is a difference between the want that gives 
value to wheat and the want that gives value to a 
medium of exchange. The former is wanted for 
personal consumption or for use in production, 
while the latter is wanted to secure something else 
that may be used for personal consumption or in 
production. But in an exchange of a commodity 
for a medium, both are bought and both are sold. 
The main difference between an exchange where a 
medium is employed and one where commodities 
are exchanged for each other directly, lies in the 
fact that in the former case two exchanges are 
necessary, where in the latter, one suffices. 

The essential character of an exchange is still 
further concealed, when the same commodity serves 
to perform the functions both of a medium of ex- 
change and of a standard measure of value, as is 
now the case with gold in the United States and 
silver in Mexico. Here, as elsewhere, price is 
determined by comparing the values of the two 
commodities exchanged, but only one is thought of 
as a commodity. Under these circum^stances, to 
discover the real nature of an exchange, it becomes 
almost indispensable to revert to the simple case 
in which commodities are exchanged for each other 
directly and their prices are determined by a com- 
parison of their values with each other. 



208 THEORY OF ECONOMICS 

The foregoing consideration of the process of 
exchange leads to the following conclusions : — 

(1) Under division of function, as society is now 
organized, the share of each member of society is 
received whoU}^ or in part through an exchange of 
commodities. 

(2) In so far as the share of any one is secured 
through exchange, the size of the share depends 
upon the amount sold and the price obtained. 

(3) Price, which is value expressed in terms of a 
measure, falls when competition prevails, and rises 
when monopolization prevails, being, in any given 
case, the resultant of these opposing manifestations 
of activity. 

(4) Healthy trade and, therefore, efincient dis- 
tribution, require that competition and monopoliza- 
tion should be properly balanced. 



THE SHARES IN DISTRIBUTION 

95. As has been seen, in society under its pres- 
ent organization, product is distributed mainly on 
the basis of value of services. In so far as differ- 
entiation in the ownership of the factors of produc- 
tion, — situation, capital, enterprise and labor, — 
exists, there result distinct shares corresponding 
to each, so that were ownership in these factors 
wholly differentiated, there would be four distinct 
shares. These are designated respectively rent, 
interest, profits and wages. These terms serve 
to distinguish the several shares from each 
other and also to distinguish the amount that 
is given in exchange for the use of the fac- 
tors from that given in exchange for the factors 
themselves, in case of a transfer of ownership, as 
where situation and capital are bought and sold. 
In this connection it is necessary to guard against 
the tendency to consider rent, interest, profits and 
wages, not only as distinct funds, but also as dis- 

Walker, Political Economy, Pt. IV., chapters i., vii.; Ely, 
Outlines of Economics, Bk. II., Pt. III.; Gide, Political 
Economy, trans., Bk. IV., Pt. II.; Mill, Principles of Polit- 
cal Economy, Bk. II., chapter iii. 

209 



210 THEORY OF ECONOMICS 

tinct kinds of funds. They are but special terms 
to designate the portions of product that go to the 
owners of the several factors of production, and a 
full appreciation of this fact will assist in under- 
standing both the relation of the shares to each 
other and the principles determining them. 

In actual business, these shares, considered 
purely as returns for the respective factors, sel- 
dom or never appear entirely separate from each 
other, because absolute differentiation in the 
ov/nership of the factors seldom or never ap- 
pears. Still it is important to consider each 
of these shares by itself in order to ascertain 
what it would be, if it were wholly distinct from 
the others. This will throw light upon the princi- 
ples determining the shares actually received by the 
social classes, which represent more or less com- 
pletely differentiated ownership in the factors. 

96. The first requisite for ascertaining the laws 
which regulate the amount of the several shares, is 
to arrive at a clear understanding of what it is that 
is to be distributed. To this end, it may be well to 
recall that distribution is part of the general eco- 
nomic process, and that the necessity for distribution 
arises from the fact that men cooperate to produce 
the means to satisfy wants. The natural and cor- 
rect inference from this is that the fund to be dis- 
tributed consists of the output of production. The 
question here raised is, what are the relative 
amounts of this output that go to the owners of 
the several factors. 



THE SHARES IN DISTRIBUTION 211 

But in the process of production, economic energy 
is expended and if the efficiency of production is 
to be maintained, the energy expended must be 
renewed. The further queston arises, then, as to 
whether the inquiry concerns the distribution of 
total product or only of a net product which re- 
mains after deducting that which is necessary to 
restore the efficiencj^ of the factors. 

Whether or not it is held to be a matter of 
indifference to take, as the fund whose distribu- 
tion is to be analyzed, total product or net product, 
it is clear that one or the other should be selected. 
Scientifically, it is not permissible to include in 
some of the shares only the net returns above the 
expense of renewing the corresponding factors, and 
then to compare such shares with others from 
which no such deduction has been made. For ex- 
ample, interest is commonly considered to include 
onl}' the amount that goes for the services of capital 
over and above what is used to maintain the capital 
fund unimpaired, while wages are considered to in- 
clude the entire return to the owner of labor, no 
deduction being made for the amount required to 
restore the strength and efficiency of the laborer. 
To place the law governing the net return to the 
owner of capital in the same class with the law 
governing the gross return to labor is illogical. 
The matter will be much simplified if the attention 
is directed at once to total product, so that the 
question becomes one of ascertaining the laws that 
govern the distribution of total product among the 



212 THEORY OF ECONOMICS 

owners of the four factors, situation, capital, enter- 
prise and labor. Total product will then equal the 
sum of rent, interest, profits and wages. ^ 

Furthermore, in seeking the principles of dis- 
tribution, the several shares should be viewed 
purely as returns for the services of the correspond- 
ing factors of production. The results so obtained 
may afterwards be compared with the funds to 
which the terms rent, interest, profits and wages 
are applied in general business intercourse. To 
avoid confusion, the terms rent, interest, profits 
and wages, qualified where it may seem necessary 
by "economic," as "economic rent," "economic 
interest," etc., will be employed in referring to 
the shares viewed from the standpoint of economic 
theory, while the terms "commercial rent," " com- 
mercial interest," etc., will be employed in refer- 
ring to these shares as they appear in actual busi- 
ness. 

97. The amount of each share under the pre- 
vailing system of distribution, depends primarily 
upon the value of the services of the factors, 
which, in turn, depends upon the relation of the 

1 Taxes, which are sometimes added as a fifth share, are 
in fact paid out of what has been received as rent, interest, 
profits or wages. Where the state reserves a portion of the 
product before the individual members of society receive 
their shares, either it does so as the owner of one or more of 
the factors of production or it adopts this method of collect- 
ing revenue from its citizens by levying upon income at its 
source. Cf. Walker, Political Econo7>iy, p. 272. 



THE SHARES IN DISTRIBUTION 213 

supply of the services of the several factors to the 
demand therefor. Thus, rent depends upon the 
relation of the supply of the services of situation 
to the demand therefor ; interest, upon the relation 
of the supply of the services of capital to the de- 
mand therefor; profits, upon the relation of the 
supply of the services of enterprise to the demand 
therefor ; and wages, upon the relation of the sup- 
ply of the services of labor to the demand therefor. 
For the principle that applies to the value of the 
services of the factors of production, differs in no 
respect from the principle according to which value 
in general is determined. Furthermore, if the sup- 
plj^ of the services of any factor increases relative 
to the demand therefor, the value of those services 
will decrease, and if the supply decreases relative to 
the demand therefor, the value will increase. As 
with commodities in general, the supply at any 
time is not the amount in existence ; it is the 
amount actually available under given conditions. 
On the other hand, the demand is not the indefinite 
want for services in general, but the specific want 
for the services of the factors actually existing 
under the prevailing conditions. 

The value of the services of the factors being 
determined by the relation of the supply of each to 
the demand therefor, the return to the owner of 
any factor, in so far as its services are sold, de- 
pends upon the conditions determining the rate of 
sale, 2. <?. , the price. Price is the resultant of the 
workings of competition and monopolization.^ The 

iSee ?91. 



214 THEORY OF ECONOMICS 

amount, then, of product that will go to the owners 
of the several factors through exchange, depends 
upon the relative extent to which they are subject 
to the influences of competition and monopolization. 
In so far as competition prevails in connection with 
the sale of the services of any factor, i. e. , in so far 
as alternatives exist that may be preferred to it, the 
share accruing to its owner will decrease ; in so far 
as monopolization prevails, i. e., in so far as the 
owner of any factor controls the alternatives that 
might be preferred, the share accruing to him will 
increase. 

These, then, are the principles which determine 
the amount of rent, interest, profits and wages. 
There exists a certain amount to be divided, i. e., 
total product. This is determined by the efficiency 
of production. The relative amounts which the 
owners of situation, capital, enterprise and labor 
receive for the services of their factors, depend 
upon the status of competition and monopolization. 
If the amount produced by a given quantit)^ of the 
factors of production is ten bushels of wheat, the 
proportion of the wheat which will become rent, 
interest, profits and wages, depends upon the ex- 
tent to which competition and monopolization pre- 
vail in connection with the sale of the services of 
the factors. Thus if, in a given case, the laborers 
possess a large control over the sale of their serv- 
ices, either because the supply of labor is small or 
because the owners thereof act together in its sale, 
while, on the other hand, rivalry exists between 



THE SHARES IN DISTRIBUTION 215 

the owners of situation because its suppl}?- is large, 
it being in the main a matter of indifference to the 
producer whether this or that situation is secured, 
the influence of monopohzation will tend to prevail 
in determining the share of labor, while the influ- 
ence of competition will tend to prevail in deter- 
mining the share that goes for the use of situation, 
i. e., the owner of labor will secure a relatively 
large share of the total product and the owner of 
situation a relatively small share. Under opposite 
conditions as to the availability of labor and situa- 
tion, the share of labor will be relatively small and 
that of situation relatively large. The same is 
true of the relation of each of the shares to the 
others. 

Furthermore, the same principle applies in deter- 
mining the distribution of any increase in product. 
If by the application of increased amounts of one 
or more of the factors or by better organization of 
industry, the amount of wheat produced is increased 
to tv/elve bushels, the extent to which the shares 
will be affected, is determined by the extent to 
which the owners of the several factors are sub- 
jected to competition and monopolization ; the ad- 
vantage flowing towards monopolization and away 
from competition. And the same is true of the 
distribution of an increase in the value of the out- 
put that results from an increased demand for the 
commodity. If the value of an output of ten 
bushels of wheat becomes $12.00 instead of $10.00, 
as a result of an increased demand for wheat, the 



216 THEORY OF ECONOMICS 

distribution of this extra value is determined by 
the same principles that operate in determining 
the distribution of an increase in the amount of 
wheat. 

98. As is the case with exchange in general, so 
with the shares which are the returns for the serv- 
ices of the factors, there are normal minimum and 
maximum limits beyond which these shares ordinar- 
ily will not go. The principles which apply here 
are essentially the same as those which apply in 
the case of general prices. The problem is this : — 
Given a product that is to be divided among the 
owners of situation, capital, enterprise and labor, 
through the sale of the services of these factors, 
what are the minimum and maximum amounts that, 
under normal conditions, can be secured by each ? 

The minimum limit to each share is the smallest 
amount that will suffice to induce the owner thereof 
to allow the use of his factor. To the extent that 
the employment of any factor in production involves 
an impairment of its efficiency, the owner thereof 
will not, under ordinary circumstances, allow its 
use for less than will suffice to renew its efficiency. 
Indeed, this minimum limit is set by the necessities 
of production, which require the restoration of the 
energy expended as a condition of continued effi- 
ciency. Continued use of a factor without renewal 
of its productive capacity would in the end destroy 
the factor and defeat the end of the economic proc- 
ess by destroying power to produce. 

The maximum limit of the share which the owner 



THE SHARES IN DISTRIBUTION 217 

of any factor can secure under normal conditions is 
the difference between the total product and the 
sum of the minimum limits of the other shares. 
Given the minimum limits of the shares, the max- 
imum limit of any share is determined by a simple 
mathematical computation. The most that is avail- 
able for distribution under any circumstances is 
total product, and to the extent that any share has 
its minimum limit, the maximum that can normally 
go to any other share is limited thereby. 

To the extent that competition exists among the 
owners of any factor, their share will tend towards 
its minimum limit ; while to the extent that they 
can avail themselves of monopolization, their share 
will tend towards its maximum. As the prices of 
general commodities may sometimes be forced below 
cost of production, so, in the case of distribution, 
excessive competition or monopolization may at 
times drive some share below what would suflfice to 
renew the efficiency of the factor involved. Such 
an excess of competition or monopolization, how- 
ever, tends to provide its own remedy through its 
effect in impairing production. But the mere possi- 
bility that a share can fall below the normal mini- 
mum, even temporarily, is a matter of serious 
concern to society, for its consequences may not be 
temporary. 

99. From the nature of the conditions deter- 
mining the shares in distribution, it follows that 
the immediate effect of an increase in the share ac- 
cruing to the owner of any factor is a decrease in 



218 THEORY OF ECONOMICS 

some one or more of the other shares, and that a de- 
crease in any share has for its immediate effect the 
increase in one or more of the other shares. But 
the amount that is received by the owner of any 
factor is an important element in determining the 
efficienc}'' of production. Hence, if the result of an 
increase in any share is such an increase in pro- 
ductive efficiency as to lead to a corresponding in- 
crease in output, provided such increase in output 
accrues to the owners of the other shares, the ulti- 
mate result will be an increase in one share without 
detriment to the others. Indeed, since conditions 
may exist in which the increased incentive resulting 
from an increase in a share, will enlarge the fund 
for subsequent distribution beyond the amount of 
such increase in the share, it is possible that all the 
participants in distribution may ultimately profit by 
adding to one of the shares. In a similar manner, 
the decrease in any share may be more than offset 
ultimately b}- an increase in production. A decrease 
in any share will result in at least a temporary in- 
crease in one or more of the other .shares, but the 
increased incentive of those profiting thereby niay, 
under some circumstances, lead to an increase in 
the total output. The mere fact, however, that an 
increase in production follows an increase in a share, 
does not signify that an increase in one share 
has taken place without loss to an}' other share. 
Sicch a result folloivs only when in subsequent dis- 
tribution, the increased outpzU accrues to the advan- 
tage of him whose share was previously decreased. 



THE SHARES IN DISTRIBUTION 219 

To this extent, and to this extent only, are the 
interests of the owners of the different factors of 
production identical rather than antagonistic. In 
so far as there is a possibility that each may profit 
thereby, it is to the interest of all that as large a 
fund as possible should be produced. Beyond this, 
in the process of distribution, there is rivalry, and 
the distribution of product among the owners of the 
factors depends upon their relative powers of con- 
trol, subject only to the limitation that excessive 
use of the power of control by impairing the proc- 
ess of production, may defeat its own end. 

100. Competition among the owners of any of the 
factors, increases the power of control, i. e., the 
monopolization of one or more of the other groups 
of owners ; and monopolization by the owners of 
any of the factors, increases the competition among 
one or more of the other groups of owners. Thus 
competition among laborers for employment, in- 
creases the power of employers to control the terms 
of exchange, and such power of control is as truly 
monopolistic as any other. The difference between 
the power of control by employers which results 
from a formal agreement between them and that 
which results from the competition of laborers, does 
not lie in the fact that the former is monopolistic 
and the latter not, unless the same economic phe- 
nomenon is called by different names under different 
conditions. The difference in such a case is purely 
one of method of obtaining power of control, and 
power of control which affects rival interests is 



220 THEORY OF ECONOMICS 

monopolistic however it may arise. On the other 
hand, combinations among laborers which give to 
them increased power of control over the sale of 
their services, is monopolization, and increases the 
competition among employers. 

In like manner, competition among employers 
increases the laborers' power of control, i. e. , their 
monopolization of their services, while combination 
among employers or any other method by which 
their power of control is increased, increases the 
competition among laborers. The same is true of 
competition among the owners of any of the fac- 
tors and of monopolization by any of them, in rela- 
tion to the owners of the other factors. 

101. The introduction of a medium of exchange 
or of a standard unit or measure of value in no way 
alters the fundamental principles according to which 
the shares are determined. When a medium of 
exchange is employed, the amount of product finally 
accruing to the owners of the factors of production 
depends upon the amount of the medium received 
and its power to purchase commodities. Here, two 
exchanges are necessary where otherwise one would 
suffice, and each of these exchanges is subject to 
the principles that govern in buying and selling. 
It is often desirable to distinguish between that 
which the owner of a factor receives in a medium 
of exchange and that which ultimately comes to 
him, so the shares are sometimes called "nominal" 
when reference is made to the amount received in 
the medium of exchange, and "real" when the 



THE SHARES IN DISTRIBUTION 221 

amount of the medium received and its purchasing 
power are meant. The use of a standard measure 
of vahie in connection with the sale of the services 
of the factors, as in the case of exchange in general, 
involves the determination of price by comparing 
the value of the services and of that which is re- 
ceived in payment therefor, with the value of a 
third commodity, instead of with each other di- 
rectly, as would be done in the absence of a standard 
measure. 

While, however, the employment of these aids to 
exchange does not alter the fundamental principles 
involved, they are not without special influence 
upon distribution. The purchasing power of the 
medium of exchange and the value of the standard 
measure are subject to variations. A fall in the 
power of the medium of exchange to purchase gen- 
eral commodities will decrease the shares unless 
there is a corresponding rise in the price of the 
services of the factors, and the opposite effect will 
follow a rise in the general purchasing power of 
the medium of exchange, when unaccompanied by 
a fall in the price of the services of the factors. A 
similar effect follows from changes in the value of 
the standard measure. If, when a change occurs 
in the value of the standard measure, the prices of 
the services of the factors vary exactly as do the 
prices of general commodities, such change in the 
value of the standard measure, though affecting the 
nominal shares, will not alter the real shares. But 
the prices of the services of the factors do not nee- 



222 THEORY OF ECONOMICS 

essarily nor presumably change coincident and coex- 
tensive with changes in the prices of commodities. 
It is doubtless true that when changes occur in 
the prices of general commodities, there tends to 
follow a readjustment of the prices of the services 
of the factors, but such readjustment is accom- 
plished, if at all, through the working of competi- 
tion and monopolization, as in the ordinarj^ deter- 
mination of prices. Hence the introduction of a 
medium of exchange and of a standard measure of 
value, subject as they are to fluctuations, intensifies 
the advantages or disadvantages inherent in the 
several factors in their relation to monopolization 
and competition. And w^hile, even under these 
conditions, there can be no doubt that the advan- 
tages to society from the use of a medium of 
exchange and of a standard of value, vastly exceed 
any incidental disadvantages, still the possible 
effect of fluctuations in the value of these upon the 
shares, emphasizes the desirability of securing as 
stable standards and media of exchange as possible. 
The analysis of the division of product into 
rent, interest, profits and wages, gives the following 
principles of distribution : — 

(1) The shares are the returns for the services 
of the several factors of production and are subject 
to the general law of value. 

(2) The value of the services of any factor de- 
pends upon the relation of the supply thereof to the 
demand therefor, varying as demand and inversely 
as supply varies. 



THE SHARES IN DISTRIBUTION 223 

(3) The amount of any share at any time is the 
resultant of the influence of competition and mon- 
opolization upon the sale of the services of the 
corresponding factor. 

(4) The normal minimum limit to each share is 
the amount necessary to bring the corresponding 
factor into activity ; the normal maximum limit is 
the total product less the sum of the minimum 
shares of the other factors. 



RENT 

102. Rent is the return to the owner of situation 
for- the ser^'ices thereof. The principles of distribu- 
tion as applied to rent may be thus stated: — Rent 
depends primaril}'- upon the value of the services of 
situation; the value of the services of situation de- 
pends upon the relation of the supply thereof to the 
demand therefor. The amount of rent received by 
the owner of situation from the sale of the services 
thereof is determined by the competitive and monop- 
olistic conditions prevailing. The normal downward 
limit to rent is the smallest amount that will suffice 

Ricardo, Principles of Political Economy and Taxation, 
edited by E. C. K. Gonner, chapter ii.; Walker, Political 
Economy, Pt. IV., chapter ii.; Laughlin, Elements of Polit- 
ical Economy, chapter xxii.;Gide, Political Economy , trans., 
Bk. IV., Pt. I., chapter iii., (\'i.); Pt. II., chapter iv., (ii., 
iii.); Ely, Outlines of Economics, Bk. II., Pt. III., chapters 
i., ii. ; Clark, The Distribution of Wealth, (see index); 
Jevons, Theory of Political Economy, chapter vi.; Mill, 
Principles of Political Economy, Bk, II., chapter xvi. ; Mar- 
shall, Principles of Economics, Bk. VI., chapters ix., x.; 
Sidgwick, Principles of Political Economy , Bk. II., chapter 
vii. ; Pantaleoni, Pure Economics, trans., Pt. III., chapter 
iv.; Von Wieser, Natural Value, trans., Bk. III., Pt. II.; 
Roscher, Political Economy, trans., Bk. III., chapter ii. 

221 



RENT 225 

to induce the owner of situation to permit its use. 
For, if through the influence of competition among 
the owners of situation, rent falls below this point, 
situation becomes idle, and the decrease in the avail- 
able supply of situation tends to check the fall in 
rent. The normal upward limit to rent is the dif- 
ference between the total product and the minimum 
shares of interest, profits and wages. For, if 
through monopolization by the owners of situation, 
rent increases so as to encroach upon the mini- 
mum limits of some of the other shares, there will 
follow a decrease in the available supply of the cor- 
responding factors. This will lead either to an 
increase in the shares that have fallen below the 
minimum or to an impairment of the efl&ciency of 
production, a condition that in itself will tend to 
diminish rent by decreasing the amount of wealth 
available for distribution. 

103. Situation as a factor of production, usually 
exists in conjunction with capital in some form, 
generally soil. Hence rent is commonly considered 
by economists, to be a return for the services of 
land, though this concept is often qualified by 
adding to land other natural agents, and limiting 
all to their unimproved state. But so far as the 
nature of the services rendered to production is 
concerned, there is no difference between the func- 
tions performed by unimproved and those performed 
by improved land. Indeed, in so far as the function 
of material may be said to consist in embodying 
want-attracting power, there is no essential differ- 



226 THEORY OF ECONOMICS 

ence between the function performed by soil and 
that performed by other material commonly recog- 
nized as capital. The return, then, for the use of 
soil should not be considered as constituting a 
different share from the return for the use of such 
commodities as cattle, iron, lumber and cotton. 

Nor can the definition of rent as return for the 
use of unimproved land and other natural agents be 
justified on the ground that this corresponds with , 
the popular use of the term. For in popular usage, 
so far as * the nature of rent is concerned, no 
distinction is made between improved and unim- 
proved land; nor, indeed, is rent in business inter- 
course limited to the return for the use of land. In 
common phrase, the term rent is employed with 
varying consistency in transactions which involve 
the loan of any commodity as distinguished from 
the sale thereof. Thus in popular language, one 
pays rent for a factory, a farm, a machine, or any- 
thing else, when he obtains the right to use it with- 
out acquiring the legal title to the ownership of it. 
In case of such a loan, it is expected that the com- 
modity itself will be returned to the owner. Com- 
mercial rent is thus to be distinguished from 
economic rent, whether the latter is considered as a 
return for the use of unimproved land and other 
natural agents, as in many economic treatises, or as 
a return for the use of situation only, the view here 
accepted. 

Moreover, since situation usually appears in con- 
junction with some other factor of production. 



RENT 227 

economic rent, considered as a return for situation 
only, rarely, if ever, appears in actual experience 
as an entirely distinct share. A share in distribu- 
tion would be pure economic rent only when the 
services of the other factor or factors associated 
with the situation, had no value. Thus when a 
share is received in return for the services of sit- 
uation and capital, as in the case of a payment for 
the use of a farm, it is a combination of economic 
rent and economic interest, unless the services of 
the capital involved are without value. 

The essential difference between rent and the 
other shares is sometimes held to arise from the 
peculiar nature of the law governing rent. Ac- 
cording to this view, the distinguishing character- 
istic of rent is the fact that it is due to and deter- 
mined by the difference in productive efficiency of 
different portions of the factor for whose services it 
is a remuneration. This leads to the inference that 
such differences in the case of the other factors 
do not affect the return for their services. But 
differences in productive efficiency in capital, en- 
terprise and labor, cause very marked differences in 
the returns for the use of different portions of each 
of these ; nor can any valid reason be given why 
such differences should be considered as of prime 
importance in connection with rent and of inci- 
dental or no importance in connection with the 
other shares. 

The failure to recognize the fact that differences 
in productive efficiency affect the returns in the case 



228 THEORY OF ECONOMICS 

of each of the factors is largely due to the method 
of estimating those returns. Rent is computed on 
the basis of a unit of area; interest, on the basis of a 
unit of the value of capital; profits, usually, on the 
basis of a unit of the value of product, though 
sometimes on the basis of a unit of the value 
of that which is invested in an undertaking; 
and wages, on the basis of a per capita unit. 
These methods of computing the several shares 
suflSce in making comparison between returns 
for different portions of the same factor, but a 
comparison of the principle determining a per acre 
return for situation (or land) with that deter- 
mining a per cent, of value of capital return 
for capital, and a per cent, of value of product 
return for enterprise, and a per capita return 
for labor, involves a disregard of logical con- 
sistency. The effect of this in obscuring the influ- 
ence of differences in the productive efficiency of 
different portions of the factors appears with special 
clearness in the case of interest. Differences of 
quality in capital manifest themselves in differences 
in the value of capital. Where, then, the owners of 
capital receive the same rate per cent, of value, it 
is inferred that differences in quality are without 
influence upon the returns. But it is evident that 
if each of two persons loans a machine of the same 
character except that one of them is antiquated, 
while the other possesses the latest and most effi- 
cient improvements, differences of quality will have 
as great an influence on the returns as in the case 
of situation (or land.) 



RENT 229 

104. Such differences as exist between the condi- 
tions determining rent and those determining the 
other shares, — and the extent of such differences 
has been greatly overestimated, — arise from differ- 
ences in the potency of competition and monopoli- 
zation in their relation to the several factors of 
production. Situation is immovable, hence its 
relation to production can vary only with move- 
ments in population or changes in transportation 
facilities. This fact tends to give very definite 
limits to the operation of competition and monop- 
olization in the sale of the services of situation. 
Since the supply of situation available for any 
given demand is fixed by nature, the number of 
available alternatives in any given case is definitely 
limited; and since no portion of supply can, phys- 
ically speaking, be substituted for another, the 
ownership of any specific portion of supply is in a 
high degree monopolistic. Accordingly, as popu- 
lation increases and with it demand for situation, 
the price of the services of situation will tend to 
increase. 

Owing to the limits placed by nature upon 
the supply of situation, it follows that whatever 
differences there may be in the productive efficiency 
of two areas in use for the same market, will tend 
to redound to the advantage of the owner of situa- 
tion. Thus the owner of a lot in the center of New 
York City can secure from the sale of its services 
nearly (or quite) all the advantage that it has over 
a lot in the suburbs, for since the supply of area in 



230 THEORY OF ECONOMICS 

that particular place is absolutely limited, a very- 
slight advantage allowed to the would-be purchaser 
of the services of situation will lead him to prefer 
that which is more favorably located. Nor is 
the principle here involved peculiar to situation and 
rent. It is equally true of every factor, that dif- 
ferences in productive efficiency redound to the 
advantage of the owner thereof, provided the differ- 
ence is sufficiently great to affect the demand for 
the services of the factor. For where demand suf- 
fices to bring into activity different grades of any 
factor, he who owns the better grades, possesses a 
power of control over the terms of exchange which 
enables him to secure most or all of the advantage 
arising from the superior efficiency of his factor. 
To that extent at least monopolization prevails over 
competition in determining the price of the services 
of his factor. 

Though monopolization enables the owner of 
any situation to profit by its superior location 
for production, it is not to be inferred that 
competition is without influence in determin- 
ing rent. Other situations appear in competi- 
tion and tend to prevent the owner of any 
portion of this factor from securing for the use of 
its services an amount which exceeds that paid for 
other portions, by more than its superior effi- 
ciency. Thus if by reason of its nearness to market, 
the value of wheat produced on a given area exceeds 
that produced on a more distant area by $100, the 
owner of the more favorable location can secure 



RENT 231 

nearly or quite that much more rent than can the 
owner of the less favorable location. But should 
the rent demanded by the owner of the first area 
exceed that asked for the use of the other by more 
than $100, the second would become the preferable 
alternative and competition would force the rent of 
the first to fall. Furthermore, should the influence 
of monopolization ever enable the owner of situa- 
tion to exact so large a share of product as to leave 
for the owners of the other factors, less than suf- 
fices to induce them to make their factors available 
for use, there would follow a decrease in the supply 
of those factors, with the result that the control 
of the owners of the remaining supply would in- 
crease, and with that would come the power on 
their part to secure a larger share in distribution. 

105. So far as the return for situation alone is 
concerned, the minimum limit, i. <?., the lowest re- 
turn that will sufBce to induce the owner of a given 
situation to allow its use, may be very small. In- 
deed, in some instances, the owner of situation may 
allow it to be used without any return other than 
that which will maintain the efficiency of the land 
or other material associated with situation, for by 
so doing a demand may be devoloped that will later 
redound to his advantage. Thus the owner of 
situation in a sparsely settled section w^here the 
supply of situation relative to the demand therefor 
is very great, may consider it to his advantage to 
allow its use without recompense, hoping thereby 
to induce a movement of population thither and 



232 THEORY OF ECONOMICS 

ultimatelj' to gain by the increased demand. In 
such cases there exists situation that brings no rent 
to its owner, though, strictly speaking, the owner 
invests present advantage for future gain. The 
returns which he would otherwise require for 
the use of his property, he invests in inducing 
others to conve, in order that he may subse- 
quently profit thereby, just as a merchant oc- 
casionally sells goods at or below cost in the 
hope of building up a more extensive trade. 

No-rent situation will be found, if anywhere, 
on the margin of cultivation, /. c, where the 
output of the productive process is so small 
that one can better afford to seek another field for 
his activity than pay for the use of situation there, 
as the amount remaining to him after such pay- 
ment would be less than he could secure elsewhere. 
Indeed, in actual experience the conditions on the 
margin of cultivation are often such that he who 
undertakes cultivation there, must have the entire 
product in order to live and continue operations. 
But the existence of a no-rent situation on the 
margin of cultivation is not necessarily permanent. 
Should population increase to such an extent that 
all cultivable area becomes occupied and should the 
demand for commodities raise their price above the 
expense of production, no-rent situation might en- 
tirely disappear. No-rent situation is an incident 
to rent, not an essential feature thereof. 

106. The fact that under some circumstances, 
situation mav bring no return for its services and 



RENT 233 

that the owner of situation can obtain most or all 
of the difference in product that is due to the 
superior efficiency of his situation as compared 
with other situation which serves the same market, 
form the basis of the Ricardian doctrine of rent. 

Rent as defined by Ricardo is "that portion of the 
produce of the earth, which is paid to the landlord 
for the use of the original and indestructible powers 
of the soil.'"^ 

The conditions that give rise to and determine 
rent are thus described : "On the first settling of a 
country, in which there is an abundance of rich and 
fertile land, a very small portion of which is re- 
quired to be cultivated for the support of the actual 
population, or indeed can be cultivated with the 
capital that the population can command, there will 
be no rent ; for no one would pay for the use of 
land, when there was an abundant quantity not yet 
appropriated, and, therefore, at the disposal of 
whosoever might choose to cultivate it." This de- 
scription of the "ante-rent stage of cultivation" 
has been modified by subsequent exponents of the 
theory, who say : "If the track be held by a num- 
ber of competing owners, each acting for himself, 
seeking his individual interest, no rent will be paid, 
or only a rent so small that for purposes of economic 
reasoning {^sic) we may disregard it." ^ 

"If," Ricardo continues, "all land had the same 

1 David Ricardo, Principles of Political Economy and 
Taxation, ed. by E. C. K. Gonner, p. 48, et seq. 

2 Walker, Political Economy^ p. 194. 



234 THEORY OF ECONOMICS 

properties, if it were unlimited in quantity and 
uniform in quality, no charge could be made for its 
use, unless where it possessed peculiar advantages 
of situation. It is only, then, because land is not 
unlimited in quantity and uniform in quality, and 
because in the progress of population, land of an 
inferior quality or less advantageously situated, is 
called into cultivation, that rent is ever paid for 
the use of it. When in the progress of society, 
land of the second degree of fertility is taken into 
cultivation rent immediately commences on that of 
the first quality, and the amount of that rent will 
depend on the difference in the quality between 
these two portions of land." 

' ' When land of the third quality is taken into 
cultivation, rent immediately commences on the 
second, and it is regulated as before, by the differ- 
ence in the productive powers. At the same time, 
the rent of the first quality will rise, for that must 
always be above the rent of the second, by the dif- 
ference between the produce which they yield with 
a given quantity of capital and labor. With every 
step in the progress of population, which shall 
oblige a country to have recourse to land of a worse 
quality, to enable it to raise its supply of food, rent 
on all the more fertile land will rise." To this 
exposition of the doctrine of rent, has been added 
the following important qualification : ' ' All scien- 
tific reasoning about rent is based on the assump- 
tion that the tenant will leave the soil in as good 
condition as it was when he took it. " ^ 

1 Walker, Political Economy, p. 195. 



RENT 235 

From this view of what rent is and of the condi- 
tions that give rise to it, the following law has been 
derived : 

"1. Rent arises out of differences existing in the 
productiveness of different soil under cultivation at 
the same time, for supplying the same market. 

"2. The amount of rent is determined by the 
degree of those differences. Specifically, the rent 
of any piece of land is determined by the difference 
between its annual yield and that of the least pro- 
ductive land actually cultivated for the supply of 
the market, under equal applications of labor and 
capital, it being assumed that the quality of the 
land as a productive agent, is, in neither case, im- 
paired or improved by such cultivation."^ 

107. The place occupied by this doctrine of rent 
in economic theory is unique. Generally accepted 
without question, it forms the starting-point of 
most theories of distribution, and from it are drawn 
conclusions of the highest importance. It was long 
held that the principles governing rent are peculiar 
to it and inapplicable to the other shares. This 
view still prevails so far as interest and wages are 
concerned, but some hold that the principles gov- 
erning profits are the same as those governing rent. 
Under these circumstances the Ricardian doctrine 
of rent merits further examination. 

This doctrine rests upon four hypotheses: (1) 
that the supply of cultivable land of some sort is un- 
limited ; (2) that the product which goes to renew 
the fertility of the soil is not rent ; (3) that differ- 

1 Walker, Political Economy, p. 197. 



236 THEORY OF ECONOMICS 

ences exist in the productive eflficiency of land ; and 
(4) that competition is free to the extent that mem- 
bers of society know of the existence, location and 
character of land, and are able to act upon that 
knowledge.^ From these hypotheses there follow 
two conclusions : (1) there exists under cultiva- 
tion a body of no-rent land, and (2) the difference 
between the product on no-rent land and the prod- 
uct on other land under cultivation, assuming 
equal applications of labor and capital, constitutes 
rent. The share can be no more and no less. 

Conceding the hypotheses upon which the Ricar- 
dian doctrine is based, the validity of the conclu- 
sions drawn is beyond question. But the significance 
of those conclusions, in so far as they are thought 
to throw light upon the nature and law of rent as 
compared with the other shares, disappears upon 
further analysis; for an assumption of the same 
hypotheses will give exactly the same law in the 
case of every share. Take wages for example. If 
it be assumed that the supply of labor is unlimited, 
and if from wages be excluded the amount neces- 
sary to renew the efficiency of labor, and if, fur- 
ther, differences in the efficiency of laborers be con- 
ceded and it be assumed that competition is free, 

1 The Ricardian doctrine of rent differs from that enter- 
tained in the present discussion in its concept of the nature 
of the factor for whose services rent is a return, but in con- 
sidering the validity of the reasoning employed in support 
of that doctrine, its concept of rent as a return for the use of 
land may be accepted. 



RENT ' 237 

there will exist a class of no- wage laborers, i. e., of 
laborers whose income no more than suffices to 
maintain them. Wages, then, under these assump- 
tions, being the return for the use of labor over and 
above the amount required to maintain its efficiency, 
will equal the difference between the productive 
efficiency of no-wage labor and of labor above that 
grade, equal applications of capital and land being 
assumed. 

Unreasonable as these conclusions may seem in 
connection with wages, they are equally as valid 
as those that constitute the Ricardian doctrine of 
rent. Moreover, from a scientific standpoint, in 
seeking to discover the laws according to which 
product is divided into shares, it is impossible to 
justify the use of hypotheses for the determination 
of one share that are not applicable equally to the 
others. The assumption of similar hypotheses will 
give a no-interest class of capital and a no-profit 
class of enterprise, for if the supply of these factors 
is unlimited, no one will pay more for the use of 
any portion of them than suffices to maintain its 
efficiency, unless it is of exceptional productive 
capacity. 

When the Ricardian doctrine of rent is exam- 
ined closely, it becomes evident that all that it 
seems to demonstrate is assumed in its hypotheses. 
If the assumption that the supply of land is un- 
limited, which is contrary to fact, is eliminated, 
and rent is interpreted, as defined in the Ricardian 
theory, to include all of product that goes to the 



238 THEORY OF ECONOMICS 

owner of land, whether as a direct payment or in- 
directly through its application to renew productive 
efficiency, there remains of the Ricardian doctrine 
of rent, the fact, not that rent arises out of dif- 
ferences in the productivity of land and equals 
the difference in product resulting therefrom, but 
that where land of different quality is utilized for 
supplying the same market, assuming that the 
efficiency of the other factors employed remains the 
same, nearly or quite all the difference in product 
arising from differences in the efficiency of land, 
will go to the owner of land, because under the ex- 
isting conditions the owners can avail themselves of 
monopolization to that extent. This, however, as 
has been seen, is true of the returns for the use of 
any one of the factors. 

108. One of the most important deductions from 
the Ricardian doctrine of rent is that "rent is not 
a component part of the price of commodities."^ 
By this is meant, not that where rent exists it does 
not come out of the price paid for the commodi- 
ties, but that price does not depend in an^^ way 
upon rent ; that, on the contrary, rent depends 
upon price, so that high rent is not the cause of 
high prices, but is itself the result of high prices. 
In support of this, it is said that there will not nor- 
mally be two prices for commodities in the same 
market, and that the price of any commodity must 
be high enough to pay for its production under the 
most unfavorable conditions which it maj^ be found 

^ Ricardo, Ibid., p 55. 



RENT 239 

necessary to utilize to meet existing demand. If, 
now, the product required to maintain the efficiency 
of land is excluded from rent, and it is assumed 
that competition prevails to the extent of reducing 
price to cost of production and that the supply of 
land is unlimited, so that when the demand for a 
commodity raises its price, new land is brought 
into cultivation, the product from which suffices 
only to pay current wages, interest and profits, and 
to maintain the efficiencj^ of land, the conclusions 
follow : (1) that no rent comes out of the price of 
those commodities that are produced on new land, 
for by hypothesis no rent exists there, and (2) that 
the reason why rent comes to be paid for any land 
is that the prices of commodities increase. 

The validity of these conclusions, it will be ob- 
served, rests upon the same hypotheses as does the 
Ricardian doctrine of rent. The price of a com- 
modity must undoubtedly be sufficient to pay for its 
production under the most disadvantageous condi- 
tions necessary to be utilized for the supply of exist- 
ing demand. But since the supply of land is limited, 
it may be that the cost under those conditions will 
include rent, even when the product that is used to 
restore the efficiency of land is excluded from that 
category. When, however, this product is included 
in rent, as it should be if rent is to be considered 
to include all of the return to the landlord for the 
use of land, as the Ricardian theorj^ defines it, it 
will follow that even where the supply of land is 
bej^ond the immediate needs of society, there is 



240 THEORY OF ECONOMICS 

always some rent for land that is cultivated, hence 
rent will form a part of price even under these cir- 
cumstances. 

But the conclusion is still valid, that in any 
given case, general prices do not depend upon 
rent. The price of any commodity at any time, 
assuming the value of the measure to be con- 
stant, depends upon the status of the supply of 
and the demand for the commodity ; hence the 
price of the commodity bears no necessary relation 
to the price that was paid for the use of the factors 
in producing it. But if new supplies of the com- 
modity are to be forthcoming, a price must be paid 
that will at least cover the cost of production, 
which will include enough to renew the efficiency 
of the factors. Moreover, since competition among 
the owners of the factors does not alone determine 
the condition of their availability, for the supply 
of the factors is not unlimited and the purchaser 
of their services has not always at his disposal an 
alternative, it may happen that the condition of 
renewing the supply of the commodity will involve 
the payment for the use of one or more of the fac- 
tors, of an amount above that required to renew 
the factors, in which case the price of the commod- 
ity must be correspondingly high. So that, while 
the shares do not determine the price of existing 
commodities, they influence that price, for they 
affect future supply.- The relation of rent to price, 
however, is not different in principle from that of 
interest, profits and wages. 



RENT 241 

109. Another important deduction from the 
Ricardian theory of rent is that rent represents an 
"unearned increment," since it is due, not to the 
efforts of the producer, but to the demand of the 
consumer. From this it is sometimes concluded 
that since rent is created bj^ society, it should go 
to society. 

The question as to whether society should appro- 
priate the so-called "unearned increment" does not 
pertain to this discussion. It should, however, be 
pointed out that consistency in the application of 
such a policy would require society to appropriate 
whatever portion of any of the shares is due to the 
superior quality of the factor for whose services it 
is a payment, in so far as that superiority is not the 
sole result of the efforts of the owner of the factor. 
Differences in quality result in differential gains to 
the owner of capital, enterprise and labor, as well 
as to the owner of land or situation. Moreover, if 
society is to appropriate for the general good, all 
of the value of every commodity that results from 
the demand of others than the producer thereof, it 
is difficult to see where the limit would be drawn 
between the "earned" and the "unearned" incre- 
ment, for under a system of division of function, 
most of the value of what each produces is due to 
the demand of others than himself. Under modern 
business organization, that portion of the value of 
a commodity which is not due to social demand, 
would not suffice to pay even the cost of produc- 
tion. 



INTEREST 

110. Interest is the return to the owner of capital 
for the services thereof. The amount of this share 
is determined according to the general principles of 
distribution which, as applied to interest, may be 
thus stated: — Interest depends primarily upon the 
value of the services of capital ; the value of the 
services of capital depends upon the relation of the 
suppl}^ thereof to the demand therefor. The amount 
of interest received by the owner of capital at any 
time is determined by the competitive and monop- 
olistic conditions prevailing in connection with the 

Walker, Political Economy, Pt. IV., chapter iii,; Ely, 
Outlines of Economics, Bk. II., Pt. III., chapter vi. ; Clark, 
The Distribution of Wealth, (see index); Gide, Political 
Economy, trans., Bk. IV., Pt. II., chapter iv. (iv. ); 
Marshall, Principles of Economics, Bk. VI., chapters 
vi.-viii.; Laughlin, Elements of Political Economy, chap- 
ter xvii.; Mill, Principles of Political Economy, Bk. II., 
chapter xv.; Sidgwick, Principles of Political Economy, Bk. 
II., chapter vi.; 'Boh.va.-^a.^&r^, Positive Theory of Capital , 
trans., Bks. VI., VII.; Vsiniale.oxn, Pure Econotnics, trans., 
Pt. III., chapter iii.; Roscher, Political Economy, trans., Bk. 
III., chapter iv. ; Von Wieser, Natural Vahce, trans., Bk. 
III., Pt. III.; Bk. IV., chapters i.-viii. 

242 



INTEREST 243 

sale of the services of capital. The normal down- 
ward limit to interest is the smallest amount that 
will suffice to induce the owner of capital to permit 
its use, for if through the influence of competition 
among the owners of capital, interest does not 
equal this amount, capital remains idle and the de- 
crease in the available supply of capital tends to 
check the fall in interest. The normal upward limit 
to interest is the difference between the total prod- 
uct and the minimum shares of rent, profits and 
wages. For if through monopolization by the 
owners of capital, interest increases so as to en- 
croach upon the minimum limits of some of the other 
shares, there will follow a decrease in the available 
supply of the factors involved. This will lead 
either to an increase in the shares that have fallen 
below the minimum or to an impairment of the 
efficiency of production, a condition that in itself 
will tend to diminish interest by decreasing the 
amount of wealth available for distribution. 

111. The difference between interest as here de- 
fined and the view often found in economic theory, 
is due to differences in the concept of capital. 
Capital has been variously defined as wealth em- 
ployed in producing more wealth, or as wealth that 
may be so employed, or as wealth that is intended 
to be so employed. These definitions, however, 
agree in excepting from capital, wealth in the form 
of unimproved land and natural agents, which 
are set apart as a distinct factor of production. 
Capital as here conceived consists of material,^ 

iSee §? 44, 103. 



244 THEORY OF ECONOMICS 

whose function it is to embody want-attracting 
power. According to this view, the free gifts of 
nature, such as soil and other raw materials, are as 
trul)' capital as are the raw materials that man has 
improved ; and the return for the use of soil as well 
as for the use of other forms of material, is 
economic interest. 

Interest in the commercial sense is a payment for 
the control of a certain amount of value. As so 
viewed, interest is contrasted to commercial rent, 
which is a payment for the use of specific portions 
of wealth.^ Thus, according to the popular view, 
if a man borrows a piece of land, a building and 
machinery, for the purpose of operating a manu- 
facturing establishment, he pays therefor rent (here 
designated commercial rent); while if he buys these 
on credit, he pays interest (here designated com- 
mercial interest) . In the former case, it is expected 
that at the end of a certain period, the specific 
commodities will be returned, with a recompense 
for their use; while, in the latter case, it is expected 
that at a given time the borrower will pay the 
purchase price of the commodities, together with a 
sum which will recompense the lender for the use 
of this wealth. From an economic standpoint, 
however, both cases involve a loan of capital, /. <?., 
of material, and the amount paid for the use thereof 
is interest. 

As a rule the borrower of capital in actual busi- 

' See I 103. 



INTEREST 245 

ness receives a quantity of money (or a title thereto) 
with which he purchases commodities, or he buys 
commodities on credit. The common practice of 
employing money in loaning capital tends to con- 
ceal the real economic character of the transaction. 
For it leads to the inference that loaning capital is 
S5monymous with loaning money, whereas what the 
borrower really wants is a supply of commodities. 
Money in such transactions is but the means through 
which the sale of the services of capital is made. 
In the case of a purchase of commodities on credit, 
the economic character of the transaction is still 
further obscured by the fact that the amount to be 
paid for the use of capital, i. <?., the interest, is 
merged in the prices of the commodities, which 
either are graded according to the length of credit 
determined upon, or, more often, are fixed on the 
assumption that payment will be deferred for a speci- 
fied time, while discounts are offered for earlier pay- 
ment. Thus, in ordinary business, goods are often 
sold on the basis of payment in 90 days, and dis- 
counts, varying in amount, are given for cash pay- 
ment or for payment in 30 or in 60 days. 

The real difference between economic and com- 
mercial interest resembles the difference between 
economic and commercial rent, in that some of the 
return made for the use of capital as popularly 
viewed, often constitutes, from a scientific stand- 
point, rent or return for situation, just as some of 
what is known in business as rent, in economic 
science is interest. For example, if one buys a 



246 THEORY OF ECONOMICS 

house and lot on credit, or through the use 
of money which he has borrowed, commercially 
speaking, the entire payment that he makes for 
the use of the credit is interest, whereas from an 
economic standpoint it is a combination of in- 
terest and rent. A portion of the credit repre- 
sents the value of situation, and so much of the 
payment as constitutes a return for this, is 
rent; the remainder, consisting of the return for 
the use of capital, is interest. In a similar 
manner, as has been seen, that which the lessee 
of a house pays is, commercially speaking, rent, 
while in economic science it consists of both 
rent and interest. The portion that goes for the 
use of economic capital is interest; the balance, be- 
ing a payment for the use of situation, is rent. 
But economic and commercial interest are alike in 
this, that however capital may be defined, the re- 
turn for its use depends upon the relation between 
the supply thereof and the demand therefor. 

112. While situation is immovable and, therefore, 
subject to fluctuations in supply only as population 
changes or as the facilities for transportation are 
altered, capital in many of its forms possesses a 
high degree of mobility. Wheat is transported 
from the fields of Dakota, Argentine Republic and 
India to England; cotton, grown in Texas or India 
or Egypt, is manufactured in England; the tea of 
China and the coffee of Brazil find markets in every 
quarter of the globe; and these are but types of 
many forms of capital. The effect of this trans- 



INTEREST 247 

ferability of capital is a tendency to equalize the 
relative influence of competition and monopolization 
in determining interest in different places, with the 
result that the returns for the use of capital of the 
same quality tend to be the same regardless of the 
location of the demand for it. For should the de- 
mand for capital in one place exceed that in another, 
thus leading to a higher return for its use in the 
former locality, capital will tend to flow to that 
place where the return is highest and away from 
the locality where the return is lowest, with the 
result of equalizing the relation between demand 
and supply in both places. 

Important as is the mobility of capital, its equal- 
izing influence upon rates of interest represents at 
most but a tendency. Various circumstances may 
lead to different returns for capital in different locali- 
ties, and, indeed, for different portions of capital in 
the same locality. Thus the general industrial con- 
dition and the political status, as affecting the cer- 
tainty of investments and the security of contracts, 
exert a marked influence upon interest. In old com- 
munities, where business conditions are settled and 
legal institutions are well established, industrial 
undertakings will give a comparatively sure, if small, 
return, and contracts will be promptly and surely en- 
forced. The return for the use of capital will tend 
to be less in such places than in new regions where 
business ventures involve greater uncertainty and 
where, law and order being less firmly established, 
the fulfillment of contracts is less sure. The larger 



248 THEORY OF ECONOMICS 

returns for capital receiv^ed under these conditions 
has been considered by some as a distinct share, 
called premium for insurance.^ Fundamentally, 
however, it is a difference in amount paid due to 
differences in the relation of the supply of capital 
to the demand therefor. When returns for the 
use of capital are more certain, the supply available 
relative to demand will be greater than when such 
returns are less certain, hence the interest will be 
lower under the former than under the latter con- 
ditions. 

Variations in the return for the services of 
capital may be caused also by variations in the de- 
gree of mobility of capital. Though capital in many 
of its forms possesses a high degree of mobility, 
it is, of course, not capable in any event of abso- 
lutely free movement, and, under some conditions, 
it cannot be transferred from one industry to an- 
other except at great loss. This is especially true 
of investments in railroads and other industries in- 
volving large amounts of fixed capital. Such capital 
in the form of iron and other raw materials may 
possess a high degree of mobility before being 
so invested, and but little afterward. Hence, 
when conditions favor high returns to these in- 
vestments, the supply of capital can be increased 
with comparative ease; but once invested, a falling 
off in returns cannot be followed readily by a de- 
crease in the supply, for the materials used in such 

1 Walker, Political Economy, p. 225. 



INTEREST 249 

industries become from the fact of such investments, 
less adapted to others. 

Such differences in the returns for the use of 
capital as are due to varying security for the loans, 
manifest themselves in the rate of interest. Thus 
a well established government can now borrow at 
the rate of from 2% to 3%; and capital for use in 
private industry, in well established communities 
where the security offered is good, brings only from 
3% to 6%; while capital in new communities where 
the risk is greater, may bring from 10% to 15% or 
even more. On the other hand, variations in 
the returns for capital which are due to dif- 
ferences in mobility, may or may not show 
themselves in the rate of interest. Whether they 
do or do not, depends upon the method employed 
for estimating interest. Where it is estimated on 
the basis of an original investment, differences in 
interest will manifest themselves in the rate, as in 
the case of dividends on stock, a portion of which 
constitutes interest. But instead of affecting the 
rate, the influence of varying returns may show 
itself in the valuation of the capital itself, as would 
be the case if the capital were sold, when it would 
be valued by capitalizing its earning capacity at the 
current rate of interest. 

113. The normal minimum limit to interest is 
the smallest amount that will suffice to induce the 
owner of capital to make it available. In many 
cases, until capital has become fixed in a permanent 
investment, there is offered to the owner the alter- 



250 THEORY OF ECONOMICS 

native of consuming it in the final satisfaction of 
his wants, in which case, except as this fits him for 
more efficient service, future production will suffer. 
To maintain and increase the capital fund of soci- 
ety, the return to the owner of capital for its use, 
must be sufiiciently large to induce him to prefer to 
employ it in other ways than in the satisfaction of 
his final desires. 

In general, the more permanent the nature of 
an investment, the more intense will be the com- 
petition between industries, when they serve the 
same demand ; and because of this, interest on the 
capital that becomes fixed, may be forced far below 
the cost of reproducing it. Indeed, on the principle 
that some return is better than nothing, competition 
may drive the returns of such investments almost 
to the cost of conducting the business. And though 
a limit to the influence of competition in lowering 
the returns in these industries may be set by the 
possible gain from a transfer of the capital to some 
other industry, it not infrequently happens that, in 
the hope of driving the competitor from the field 
and of ultimately increasing the gain, the struggle 
between rivals becomes so intense that interest en- 
tirely disappears. In the long run, however, in- 
terest can not remain below the cost of renewing 
the efficiency of capital, for when interest falls be- 
low this, the process of production is impaired and 
economic decay sets in. 

There is also a maximum limit to interest, which 
is fixed by the minimum limits of the other shares. 



INTEREST 251 

Should the owners of capital be able to increase the 
price of its use so as to encroach upon the minimum 
limits of the other shares, the borrowing of capital 
would become unproductive to the borrower. A re- 
duction in interest would then follow either through 
a decrease in the demand of the borrowers or through 
an impairment of the productive process, which 
would decrease the fund available for distribution. 

114. As the return for the use of capital depends 
upon the relation of the supply of capital to the 
demand therefor, and the process of borrowing is 
often effected through the use of money, a belief 
exists that interest depends upon the amount of 
money. A large supply of money is supposed to 
result in low rates of interest, while a high rate of 
interest is supposed to indicate a scarcity of money. 
Because of this opinion, there arises, not infre- 
quently, a demand that the supply of money shall 
be increased in order to enable borrowers to secure 
the use of capital at less expense. 

At the basis of this demand, is the mistaken idea 
that in borrowing one desires primarily money, 
whereas the fundamental desire is for commodities. 
"The amount to be paid for the use of capital 
will depend upon its abundance compared with 
the occasion for its use. The issue of money will 
not increase the number of horses and cattle and 
plows nor will it build shops and warehouses or 
construct machinery for manufacture or transport. 
If the people of a communitj^ be thriving and pro- 
gressive, the demand for capital to start new enter- 



252 THEORY OF ECONOMICS 

prises or to enlarge those already established, will 
be very great. If the community be, also, young, 
having brought to new fields the social and industrial 
ideas, tastes and ambitions of an old society, the 
supply of capital will be scanty, and the rate of 
interest will rule high.^ ' ' 

Moreover, the misfortune involved in a condition 
where a high rate of interest prevails does not con- 
sist primarily in the high rate but in the scarcity of 
capital, an evil which the high rate tends to remedy, 
since it will induce men to apply less wealth to the 
gratification of their immediate desires, thereby 
rendering more wealth available for application in 
other directions. 

On the other hand, ' 'a low rate of interest may 
mean that, in a thriving, progressive community 
the accumulation of capital has gone on so rapidly 
as to outrun the occasions for its productive use. 
It may mean that the people are so dull, indolent 
and unambitious, or the state of society so disor- 
dered, that commercial and manufacturing enter- 
prises are not undertaken, and no enlargement of 
traditional industries is looked for. A small amount 
of capital more than sufi&ces for such scanty needs. ' ' '-^ 

It will not suffice, however, to dismiss the ques- 
tion of the relation of money to interest with the 
statement that interest is not determined hy the 
supply of nione5\ For the supply of money affects 

' Walker, Political Economy, p. 220 et seq. - Ibid, p. 221. 



INTEREST 253 

the facilities for transferring ownership and thereby 
influences the relation of the supply of and the de- 
mand for capital. Hence the supply of money 
affects interest. While an issue of money is not 
identical with the production of ' 'horses and cattle 
and plows' ' or with the building of warehouses or 
the construction of "machinery for manufacture 
and for transport," the productive operations are 
all affected by the monetary system. It is impor- 
tant to emphasize both that the rate of interest 
is not determined by the supply of money and 
also that it is not independent of the supply of 
money. 

The theory that the rate of interest is independ- 
ent of the supply of money is based upon the as- 
sumption that prices of commodities will change 
with changes in the supply of money, and that the 
general conditions of the supply of and the demand 
for capital are not affected by such changes in the 
prices of commodities as result from changes in 
the supply of money. The borrower desires to se- 
cure a certain amount of value, and since price is 
but the estimate of the value of one commodity in 
terms of some other, it would seem to follow that if 
the supply of the other commodity increases, thereby 
decreasing its value, the price of the first commodity 
will increase accordingly, even though its value re- 
mains the same. After such a change in the value 
of the measure, the price of that which is borrowed 
is greater, but if its value remains the same, the 
rate of interest is unchanged. Thus, suppose a 



254 THEORY OF ECONOMICS 

niauufacturer of clothing desires to borrow 1,000 
yards of cloth, for the use of which he is willing to 
pay 50 yards, i. <?. , 5 per cent. If at a given sup- 
ply of money the price of that cloth is $1.00 a yard, 
he will borrow $1,000 and pay therefore $50. If 
now as a result of an increase in the supply of 
money, its value decreases one-half, while the value 
of the cloth remains the same, the price of a yard 
of cloth (in terms of money) will become $2.00. 
And to secure 1,000 yards, the manufacturer must 
borrow $2,000, for the use of which he gives 50 
yards or $100, which is, as before, 5 per cent. To 
the extent, then, that changes in the supply of 
money are followed by changes in the prices of com- 
modities which correspond exactly to the changes 
in the value of mone}'', tvhile other conditions remain 
uncha7iged, the rate of interest remains the same. 
When, however, the conditions assumed as the 
basis of the theory that interest is independent of 
the supply of monej^ are compared with the actual 
workings of the economic process, it will be 
found that changes in the supply of money 
which do not affect the rate of interest are the 
exception rather than the rule. On the one hand, 
there is at any given time a large body of prices 
that are unaffected b)- changes in the value of 
money, for the prices involved in credit transactions 
are fixed. Hence in so far as the demand for capital 
is a demand for wealth to meet existing obligations, 
changes in the suppl)^ of money will affect the rate 
of interest, in accordance with the general law of 



INTEREST 255 

value. And, even though the entire influence of 
changes in the supply of monej^ were exerted 
through the relation of money to contracts, the 
effect of such changes on the rate of interest, 
would not stop with the contracts themselves, be- 
cause the conditions affecting the liquidation of 
existing contracts influence the formation of new 
ones. The demand for any and every commodity 
and, therefore, the demand for capital in all its 
forms, are affected by such changes in the supply 
of money as alter the conditions of the fulfillment 
of obligations. 

But the influence of changes in the supply of 
mone)^ on interest is not limited to that which is 
exerted through contracts. Changes in price, 
whether due to changes in the value of commodities 
or to changes in the value of money, affect directly 
the demand for and the supply of commodities. 
Hence changes in price, from whatever cause, affect 
the demand for the capital required to produce 
commodities, and, through this, the interest upon 
such capital. Business may be hampered by an 
inadequate or a superabundant supply of money, 
through which ownership in values is transferred, 
just as truly as by an inadequate or superabundant 
supply of railroads, through which the commodi- 
ties themselves are transported ; and whatever im- 
pedes or promotes business, affects the demand for 
the factors of production and, therefore, the returns 
for the services of these factors. 

While, however, changes in the supply of money 



256 THEORY OF ECONOMICS 

affect interest through their influence upon busi- 
ness conditions, it is not to be inferred that interest 
can be controlled by arbitrary readjustments of 
the supply of money. It is absolutely impossible 
to foretell the effects of changes in the supply of 
money upon interest, because it is impossible to 
foretell the effect of a given change in the supply 
of money upon the relation between demand and 
supply as they concern capital. An increase in the 
supply of money by increasing prices may quicken 
business activity and promote economic prosperity, 
thereby enlarging the demand for capital and in- 
creasing the interest returns therefor ; but if the 
supply of money exceeds the needs of business, it 
leads to inflation of prices and disaster, followed 
by a decrease in the demand for capital. On the 
other hand, the increase in prices resulting from an 
increase in the supply of money, may lead to such 
a decreased demand for commodities by purchasers 
as to decrease the demand for capital and lower the 
interest thereon. A decrease in the supply of 
money may produce exactly the opposite effects, 
leading to lower prices and business contraction, 
partly or wholly offset by increased demand for 
commodities because of low prices. 

There is no more important or certain teaching 
of economic experience than that the attempt arbi- 
trarily to adjust the supply of monej^ to the needs 
of business cannot succeed. An adequate monetary 
system must contain within itself the capacity to 
increase and decrease the supply of money according 
to changes in the demand for it. 



PROFITS 



115. Profits are the return to the possessors of 
enterprise for the services thereof. The principles 
of distribution as applied to profits may be thus 
stated: — Profits depend primarily upon the value of 
the services of enterprise; the value of the services 
of enterprise depends upon the relation of the supply 
thereof to the demand therefor. The amount of 
profits received at any time is determined by the 
competitive and monopolistic conditions prevailing 
in connection with the sale of the services of enter- 
Walker, Political Economy, Pt. IV., chapter iv.; Ivaugh- 
lin, Elements of Political Economy, chapter xx.; Clark, 
The Distribution of Wealth, (see index); Gide, Political 
Economy, trans., Bk. IV., Pt. II., chapter ii.; Ely, Outlines 
of Economics, Bk. II., Pt. III., chapters v., vi. ; Pantaleoni, 
Pure Economics, trans., Pt. III., chapter iv., § 5; Roscher, 
Political Economy, trans., Bk. III., chapter v.; Marshall, 
Principles of Economics, Bk, VI.; chapters vii., viii.; Mill, 
Principles of Political Economy , Bk. II., chapter xv. • Sidg- 
wick, Principles of Political Economy, Bk. II., chapter ix. 
See also in the Quarterly fournal of Econoinics, Vol. vii., 
459-479, "The Risk Theory of Profit," and Vol. xv., 75-105, 
"Enterprise and Profit," by F. B. Hawley ; and Vol. ix., 
409-449, "Risk as an Economic Factor," by John Haynes. 

257 



258 THEORY OF ECONOMICS 

prise. The normal downward limit to profits is the 
smallest amount that will suffice to induce the pos- 
sessor of enterprise to make it available; for if 
through the influence of competition among the 
possessors of enterprise, profits fall below this point, 
enterprise remains idle, and the decrease in the 
available supply of enterprise tends to check the 
fall in profits. The normal upward limit to profits 
is the difference between the total product and the 
mininum shares of rent, interest and wages. For 
if through monopolization by the possessors of 
enterprise, profits are increased so as to encroach 
upon the mininum limits of the other shares, there 
will follow a decrease in the available supply of the 
factors involved. This will lead either to an in- 
crease of the shares that have fallen below the 
mininum or to an impairment of the efficiency of 
production, a condition that in itself will tend to 
diminish profits b}^ decreasing the amount of wealth 
available for distribution. 

116. The fact that profits are the return to the 
owners of enterprise for the services thereof and 
that they are determined by the relation of the sup- 
ply of enterprise to the demand therefor, is obscured 
by the process through which the owner of enter- 
prise receives his share. Before the development 
of the economic organization had resulted in differ- 
entiation of the ownership of the various factors, 
each producer was the possessor of the situation, 
capital, enterprise and labor employed in his in- 
dustry. Under such an arrangement each indi- 



PROFITS 259 

vidual owned the product of his industry, and his 
share depended directly upon the value of that prod- 
uct. It was impossible to say how much of this 
product constituted the several shares, rent, interest, 
profits and wages. The same is true of many busi- 
ness undertakings today, and especially of such as 
are conducted on the margin of cultivation, i. e., 
where the total product is required to pay the ex- 
pense of production. The amount of the various 
shares under such circumstances can be estimated 
only, by assuming that each equals that which is 
received where the factors are owned by different 
persons, an assumption that must necessarily re- 
main purel}^ hypothetical. 

Through the process of differentiation of the 
ownership of the factors, it has resulted that the 
services of situation, capital and labor have become 
objects of direct purchase and sale, while the 
owner of enterprise retains the status of the pro- 
ducer in the earlier condition, in that he owns the 
output of the productive operation, subject to 
such liens as are involved in his obligations to the 
owners of the other factors. Hence the owner of 
enterprise receives his share through the sale of 
the commodity produced and after payment, from 
the proceeds of such sale, of the amounts due the 
owners of situation, capital and labor. The process 
of buying and selling enterprise is involved in the 
buying and selling of general commodities. But 
this peculiarity of the method of remunerating the 
services of enterprise does not prevent the work- 



26(^ THEORY OF ECOXOMICS 

ing of the law of suppl)' and demand in determining 
profits. So far as an 5' given undertaking is concerned, 
the o^mer of enterprise is the residual claimant, 
/. e., he pays the expenses, consisting of the returns 
for situation, capital and labor, and then takes what 
is left. But it is not to be inferred from this, that 
the amount which goes as profits is the result of 
chance. Unless the remuneration for the services 
of situation is sufficient to induce the possessor of 
enterprise to undertake an industry, there is no de- 
mand for and, therefore, no return to the other 
factors. Much uncertaint}- may attend the amount 
of profits so far as any individual enterprise is con- 
cerned, but in the long run a portion of product 
must go to the possessor of enterprise. 

The nature of enterprise is such that the supply 
is not easily increased to meet demand. This 
fact tends to emphasize the influence of monop- 
olization in regulating the returns for the services 
of enterprise. Especially is this true in the case of 
new undertakings, whether they involve the pro- 
duction of a new commodity, or the extension of 
the scope of existing industries. To interpret ac- 
curateh' the conditions of supply and demand and 
to adjust the one to the other, w^hen it is proposed 
to essa}' the production of a new commodit}- or to 
put into operation an undertaking of great .size, 
where the possibilities of failure are increased b}' 
the complexities and vastness of the organization 
and the variety of the elements involved, require 
enterprise of a high order, the supply of which is 



PROFITS 261 

not susceptible to increase by the mere increase of 
population. Hence the possessors of such enterprise 
exercise a large power of control in the sale of 
its services. And as the importance to economic 
progress of changes in the nature and magni- 
tude of undertakings increases, the demand for 
enterprise increases, and with it the necessity of 
giving for the services of enterprise such an amount 
of product as shall attract an adequate supply 
thereof. 

Another important characteristic of enterprise 
is found in the variety of grades in which it ap- 
pears. Some degree of enterprise, as has been ob- 
served, is inseparable from all activity, but there is a 
vast difference between the enterprise that leads one 
to act where the task is simple and the returns well- 
nigh sure, as in the case of the ordinary forms of 
labor, and that which is required in the large rail- 
road and mercantile operations of modern industry. 
These differences in the grade of enterprise result in 
differences in the returns for the services of enter- 
prise. The amount of profits that suffices to pay 
for the enterprise involved in running a small 
country grocery store and that which affords the 
proper remuneration for the enterprise essential to a 
transcontinental railroad are vastly different. But 
the difference between the profits actually accruing 
from such undertakings is not greater than the 
difference between the value of the services of the 
enterprise involved. 

The minimum of profits is the smallest amount 



262 THEORY OF ECONOMICS 

that will induce the possessor of enterprise to 
act. If economic efficiency is to be maintained, 
profits must suffice to maintain the efficiency of 
enterprise. But in very many instances, the pos- 
sessor of enterprise supplies also the labor and per- 
haps the capital and situation, and may engage in 
business for himself merely because of the satisfac- 
tion arising from being an independent producer, 
even when the total income so obtained is no larger 
than he could get by selling to others the use of his 
situation, capital and labor. Under these con- 
ditions the gratification of the desire to be one's own 
employer constitutes part of the return to the pos- 
sessor of enterprise, while the amount of each of 
the several shares, as has been said, cannot be dis- 
tinguished. 

117. The existence of marked differences in grades 
of enterprise, and the fact that, under some circum- 
stances, a very low minimum of profits suffices to 
induce enterprise to act, have led to a theory of 
profits akin to the Ricardian doctrine of rent, and 
called after that, the "rent theory of profits."^ 
According to this theory, if (1) "the number of men 
of exceptional abilities were sufficient or more than 
sufficient to do all the business that required to be 
done, of all sorts and in all places; if (2) these 
men, however much surpassing all other members 
of the industrial society, were themselves equal in 
all respects which concern the conduct of business; 



' Walker, Political Ecofiomy, p. 232 et seq. 



PJiOFITS 263 

and if (3) this class, so constituted and so endowed, 
were distinguished from all not of their class so 
clearly and conspicuously that no one having these 
exceptional abilities should fail to be recognized, 
and no one lacking such abilities in the full measure 
should esteem himself capable of conducting busi- 
ness, or be so esteemed, for the purpose of obtaining 
credit, we should have a situation closely analogous 
to that * ^k in the case of a community near 
which was found an amount of good land, of uni- 
form quality, adequate, or more than adequate, to 
raise all produce required for the support of the 
community." 

In the absence of combination among the mem- 
bers of this class, competition, it is said, will bring 
their return "to so low a point that the remunera- 
tion of each and every one of this class would be 
practically equal to what he would receive if employed 
by another} This, which we might call the no- 
profit stage of industrial society, corresponds closely 
to the no-rent stage in the cultivation of the soil. 
The persons remaining in the conduct of business, 
would earn their necessary subsistence and no 
more. ' ' 

As a matter of fact, however, there are wide 
differences in business ability, from "those rarely 
gifted persons, who, in common phrase, seem to 
turn everything they touch into gold," to "the 
multitude of men who are found in the control of 

^ Not italicized in the original. 



264 THEORY OF ECONOMICS 

business enterprises for no good reason; men of 
checkered fortunes, sometimes doing well but more 
often ill." Those of this lowest order of ability 
constitute the "no-profit" class of employers, who 
live "partly by legitimate toll upon the business 
that passes through their hands, partly at the cost 
of their creditors, with whom they make frequent 
compositions, partly at the expense of friends, 
or by the sacrifice of inherited means. This bare 
existence, obtained through so much of hard work, 
of anxiety and often of humiliation, we regard as 
that minimum which in economics, we can treat 
as nil (sz'c). From this low point upwards we 
measure profits. ' ' 

From this theory there might be formulated the 
following law of profits, adapted from the Ricardian 
law of rent: — 

1. Profits arise out of differences existing in the 
productiveness of different portions of enterprise in 
use at the same time for supplying the same market. 

2. The amount of profits is determined by the 
degree of those differences. Specifically, the profits 
from any undertaking are determined b)' the dif- 
ference between the efficiency of the enterprise in- 
volved and the least efiicient enterprise in use to 
supply the same market, under equal applications 
of situation, capital and labor, it being assumed 
that the quality of the enterprise as a productive 
agent is, in neither case, impaired or improved by 
such use. 

118. This theory is open to substantially the 



PROFITS 265 

same criticism as the Ricardian doctrine of rent. 
It will be observed that the "no-profits" employer 
is either one whose profits are very small, in which 
case the theory proposes to ignore them altogether, 
in entire disregard of the requirements of scientific 
investigation, or he is an employer whose income is 
' 'practically equal to what he would receive if em- 
ployed by another, ' ' i. e. , to what he would secure 
as a laborer. The fallacy involved in declining to 
call a share profits, when it is return for the services 
of enterprise, just because the amount is no more 
than could be secured as wages, is apparent. If, as 
the "rent theory" assumes, profits are remunera- 
tion for organizing and conducting production,^ 
then the portion of product that goes to pay for 
this service should be called profits whether it is 
large or small. Moreover, for scientific purposes, it 
must be recognized in whatever form and to what- 
ever extent it exists. 

The essential truth in the rent-theory of profits 
is the same as that which remains to the Ricardian 
doctrine of rent after the hypotheses have been 
reduced to conform to facts and the definition of 
the share is interpreted in harmony with the 
definitions of the other shares, so as to include all 
the return for the services of enterprise. Differ- 
ences in efficiency exist in enterprise as in the 
other factors, with the result that those possessing 
the higher grades can avail themselves of monop- 

^ Walker, Political Economy^ p. 232. 



266 THEORY OF ECONOMICS 

olization to the extent of securing most or all of the 
increase in product that results from their increased 
efficiency. But this, as has been seen, is equally 
true of all the factors of production, though the 
fact may sometimes be concealed by the method of 
estimating the shares. 

119. The rent-theory of profits resembles the 
Ricardian doctrine of rent also in the conclusion 
drawn from it as to the relation of profits and prices. 
"Profits," it is said,^ "do not form a part of the 
price of manufactured products," by which is 
meant, as in the case of rent, that the price of com- 
modities produced under the most unfavorable 
conditions actually employed, does not include any 
profit because no profit exists there. And since 
the price under such conditions determines the 
price everywhere, profits do not form a part of any 
price. The basis of this conclusion is the assumed 
existence of no-profit enterprise, an assumption 
that is contrary to fact. Indeed, the same criticism 
that was made against the similar conclusion in 
connection with rent, applies here.- 

It is undoubtedlj^ true that the price of au}^ com- 
modity at a given time does not depend upon profits, 
nor does it depend directly upon any or all of the 
shares. Price is a comparative estimate of values 
and these depend upon the relation of the supply 
of to the demand for the commodities concerned. 
In general, too, the shares depend upon prices 

1 Walker, Political Economy, p. 239. ^ See ? 108. 



PROFITS 267 

rather than prices upon the shares. Where commod- 
ities are produced for sale, the amount to be dis- 
tributed among the owners of the factors is the 
amount received from such sale. Moreover, in 
actual business, profits are more directly affected by 
variations in the prices of commodities than are the 
other shares; for rent, interest and wages are often 
paid out of wealth which has been advanced for 
that purpose, while the receipt of profits may wait 
upon the sale of the commodities produced. But, 
as has been seen, if new supplies of any commodity 
are to be forthcoming, the price received at any 
given time must be sufficient to pay the rent, inter- 
est, profits and wages, which are necessary to 
secure the activity of the factors. So that the 
prices of commodities are influenced by the shares, 
for these affect the future supply of and demand 
for commodities. 

The attempt to show that prices are independent 
of profits and a somewhat similar attempt to show 
that profits cannot normally affect wages, ^ result 
apparently from a desire to justify the existence 
of profits and to demonstrate that the laborer 
suffers no loss in wages because of profits. The 
existence of profits should require no justification. 
The services of enterprise are indispensable to pro- 
duction, and while the justice of allowing a return 
therefor is primarily a question of ethics, it may 
here be remarked that it would be a strange code 

^ See infra. 



268 THEORY OF ECONOMICS 

of ethics that would deny to the possessor of enter- 
prise the right to a return for its services. Whether 
profits can be increased at the expense of wages or 
of any other share depends upon whether the pos- 
sessors of enterprise can obtain such a control over 
its supply as, through the influence of monopoliza- 
tion, to secure some of product that would other- 
wise go as wages or as some other share. 

120. In judging of profits and of their relation to 
total product in any given case, account must be 
taken of the method employed to estimate profits. 
In this connection it is necessary to distinguish 
between the rate of profits reckoned as a percentage 
of the value of the investment, the rate reckoned as 
a percentage of the price of a single commodity and 
profits as the portion of the total output of a given 
industrial operation that goes to the possessor of 
enterprise. In business transactions the first two 
methods are most commonly employed. Thus, if 
an industry with an investment of $100,000 yields 
$10,000 profits, the share is said to be 10%. This 
estimate is useful for comparing the returns to enter- 
prise in different industries or in the same in- 
dustry at different times, but it does not enable one 
to judge of the relation of profits to the other 
shares, nor of the sufficiency of profits in relation to 
economic efficiency. To decide these questions it is 
necessary to consider the character of the industry, 
and the amounts that go as returns for the other 
factors. The element of time also must be taken into 
account. The opinion as to the adequencj' of the 



PROFITS 269 

profits in the illustration given, will vary materially 
according as the sum received represents the returns 
accruing in a month, a year or ten years. If the 
$10,000 represents a month's return, it will be con- 
sidered high; if it represents a year's income, it 
will be considered good or fair according to the 
nature of the business; but if it represents the re- 
turn for ten years, it will probably be considered 
insufficient to warrant the continuance of the busi- 
ness, unless this is necessary to save the invest- 
ment. Again, if a commodity that sells for $1.00 
returns a profit of 50 cents, the rate, 100%, seems 
to be very high. If, however, the sale of one such 
commodity took all the service of one man's enter- 
prise for a day, such profits would not attract a 
very high order of enterprise. 

Moreover, in estimating the total outlay that 
society makes to secure the enterprise requisite for 
the economic process and in comparing this with 
the remuneration for the services of the other fac- 
tors, too much stress should not be laid upon the 
large amount of profits that may be received in 
individual instances. Business under modern eco- 
nomic conditions is highly speculative, and the loss 
in case of failure is often very great. The total 
amount that goes to enterprise must be sufficient in 
the long run to insure against failure, else the 
probability of loss may outweigh the probability of 
gain and society will suffer from industrial stagna- 
tion. Without attempting to decide here the ques- 
tion as to whether profits are excessive, it may 



270 THEORY OF ECONOMICS 

confidently be affirmed that much of the behef that 
such is the case, arises from ignorance as to the 
extent to which failure and loss attend the attempt 
to launch business undertakings. Success is her- 
alded, while, so far as possible, failure is concealed. 
The correct basis for deciding as to whether 
society, under the prevailing system of distribution, 
is compelled to pay too much for the services of 
enterprise, is neither the absolute nor the relative 
incomes of its members, but the relation between 
what it secures from enterprise and what it pays 
for it. If an equally efficient enterprise can be 
secured at a lower price, too much is being paid for 
the services of this factor under present conditions; 
if, however, a decrease in profits would result in 
lessening the efficiency of enterprise, then the pres- 
ent payment therefor is not excessive, however 
large may be the amount received by those who 
supply the service. 



WAGES 

121. Wages are the return for the services of 
labor. The principles of distribution as applied to 
wages may be thus stated : — Wages depend primarily 
upon the value of the services of labor; the value 
of the services of labor depends upon the relation 
of the supply thereof to the demand therefor. The 
amount of wages received in any given case is de- 
termined by the competitive and monopolistic con- 
ditions prevailing in connection with the sale of the 
services of labor. The normal downward limit to 
wages is the smallest amount that will induce men 
to work, for if through the influence of competition 

Walker, Political Economy, Pt. IV., chapters v., vi.; Gide, 
Political Economy, trans., Bk. IV., Pt. II., chapter iii. ; 
Taussig, Wages and Capital; Clark, The Philosophy oj 
Wealth, chapter viii. ; The Distribution of Wealth (see in- 
dex); Laughlin, Elements of Political Econom,y, chapters 
xviii.-xxi.; Ely, Outlines of Economics, Bk. II., Pt. III., 
chapter iii.; Pantaleoni, Pure Economics, trans., Pt. III., 
chapter v.; Roscher, Political Economy, trans., Bk. III., 
chapter iii.; Sidgwick, Principles of Political Economy, Bk. 
II., chapters viii., ix. ; Marshall, Principles of Economics, 
Bk.VI., chapters ii.-v.; Mill, Principles of Political Economy, 
Bk. II., chapters xi.-xiv. 

271 



'2r2 THEORY OF ECONOMICS 

among laborers, wages fall below this point, men 
remain idle and the decrease in the available supply 
of labor tends to check the fall in wages. The 
normal upward limit of wages is the difference be- 
tween the total product and the minimum shares of 
rent, interest and profits, for if through monopoli- 
zation by laborers, wages increase so as to en- 
croach upon the minimum limits of some of the 
other shares, there will follow a decrease in the 
available supply of the factors involved. This will 
lead either to an increase in the shares that have 
fallen below the minimum or to an impairment of 
the efRciency of production, a condition that in 
itself will tend to diminish wages by decreasing the 
amount of wealth available for distribution. 

122. In actual business, labor is never active with- 
out some degree of enterprise, for it requires some 
enterprise to put into operation aiay undertaking, 
even that of utilizing one's labor-power for produc- 
tion. This is true of the simplest forms of activity, 
sucli, for example, as where the process of want- 
satisfaction requires only the appropriation of fruits, 
water or fuel, which exist in such abundance that 
thej^ may be had for the taking. From this it fol- 
lows that a pure economic wage, /. <?. , a return for 
the serv'ices of labor wholly distinct from the other 
shares, exists only where the value of the ser\'ices 
of the enterprise involved amounts to nothing. 
Such a condition, absolutely speaking, does not ex- 
ist. But for business purposes, the value of the 
services performed by enterprise in any given case 



WAGES 273 

may be so small as to be ignored in actual trans- 
actions, just as the carpenter ignores the indefinitely 
small differences in length, which are, at the same 
time, important in the effort to discover the funda- 
mental principles upon which the carpenter bases 
his acts. Commercial wages, then, differ from eco- 
nomic wages in that the former contain at least a 
modicum of profits. This fact, however, does not 
prevent the recognition of the principles which 
govern economic wages, principles that regulate 
also the wages in actual business. 

Moreover, in seeking the principles according to 
which wages are determined, a distinction must be 
recognized between the total amount of wages ac- 
cruing in a given undertaking and the rate of wages 
for individual laborers. The former refers to the 
total amount of product that goes to pay for the 
services of labor as compared with the amount that 
goes to pay for the services of the other factors, 
situation, capital and enterprise ; while the rate of 
wages refers to the proportion of total wages re- 
ceived by individual laborers. The two questions 
are intimately connected, but they are by no means 
identical. Differences in rates of wages to in- 
dividual laborers do not indicate differences in the 
proportion of total product which constitutes wages. 
If, in an industry which requires 10 laborers, each 
receives $2.00, while in another having an equal 
output, 20 laborers are required, each of whom re- 
ceives but $1.00, the proportion of total product 
which constitutes wages is the same in both. 



274 THEORY OF ECONOMICS 

123. A characteristic of labor that is of much 
importance in determining wages is the insep- 
arabiHty of the owner of the factor and the 
factor itself. Labor is inseparable from the penson 
of the laborer ; where the one is, the other must be 
also. The owner of situation may be in one place 
and his property in another. The same is true of 
the owner of capital and his capital. Even the 
possessor of enterprise is not so bound to the scene 
of the industry to which he contributes as is the 
laborer, for the former ma}^ reside in one place while 
his ventures are in other localities, whereas the 
laborer must be where he labors. 

The significance of this difference between labor 
and the other factors lies, not in the fact that dif- 
ferent laws regulate the returns for the factors, but 
in the fact that different conditions attend the 
operation of the law. All shares are subject to the 
law of value, but the conditions under which com- 
petition and monopolization operate to determine 
the relation of supply'- and demand are materiallj' 
modified in the case of labor, bj'- the fact that the 
person of the laborer and his Libor power are in- 
separable. The results of this appear in various 
forms, ^ but the)' maj' all be summed up in the state- 
ment that this peculiarity of labor decreases the 
laborer's power of control in the sale of his services 
because it limits the alternatives at his command. 
He who possesses only labor-power must sell his 

' Brentano, Relation of Labor to the Laxv of To-day, 
trans, by Porter Sherman, pp. 169, et seq. 



WAGES 275 

services at some price or starve. The owner of 
capital often has the alternative of consuming his 
wealth in the immediate satisfaction of his wants, 
if the terms of a proposed exchange are not satis- 
factory. The owners of situation, capital and 
enterprise, if able-bodied men, may avail them- 
selves also of the labor-power which their own 
strength and intelligence give, while he who is only 
a laborer controls but one of the factors of pro- 
duction. 

When to the inseparability of the person of the 
laborer and his labor, is added the possibility of 
rapid increase in population, which is not regulated 
by its relation to the demand for labor but depends 
upon other considerations, it is evident that the con- 
ditions attending the sale of the services of labor 
are favorable to a high degree of competition 
among laborers. Indeed, to such an extent does 
competition affect the sale of labor that, when in- 
dividual laborers are left to their own efforts, wages 
tend to the minimum, which, in the case of this 
share, may be no more than will maintain the effi- 
ciency of labor, for this often suffices to induce the 
laborer to make his services available. Indeed, 
since the laborer must either sell his services or 
starve, the smallest amount that will induce him to 
work may be below this normal minimum. It may 
be the bare cost of maintaining life. For, though 
it is true that in the long run the injuries to pro- 
duction through decrease in the efficiency of labor 
tend to prevent the permanence of such a low 



•J7(> nn-OKV OF /-coyoMics 

wage, ihc fact that the iinmciliate purchasers of 
the services of labor may not at once feel the dis- 
astrous elTects of such a reduction, makes it possible 
and oven probable that wages will at times go below 
the niMuial minimum. The consequences of this are 
serious. To impair the efficiency of the laborer is 
to limit the satisfaction of his wants, and this in- 
volves nut only an injury to the process of pro- 
duction, but also an actual ilefeat of the economic 
process itself, for the interests of the laborers who 
suffer are the interests of society. 

The possibility of excessive competition among 
laborers and its injurious results give to the labor 
problem a deserved preeminence among social prob- 
lems, and emphasize the importance of a clear 
undei-standing of the principles that regulate wages 
as regards both the total amount of wages and the 
share of each laborer. 

.121. Wages depend, fii^st of all, in conunon with 
the other shares, upon the amount produced, /. t\, 
upon the efficiency of production. This follows as 
a matter of course from the fact that the more there 
is produced, the more there is to divide. This does 
not, however, signify that the larger the product, 
the larger is the share that the laborer will receive, 
for whether the laborer gains by an increase in 
product depends upon whether he can so far avail 
himself of the intluence of monopolization as to 
secure a portion of that increase. This requires 
the more emphasis in view of a belief, current 
among some, that if the increase in product has 



IV ACES 277 

been due to the application of more laborers or of 
more efficient labor to the process of production, 
the increase in product must, under normal con- 
ditions, go to the wage fund, while if the increase 
in product is not due to la]>or, it cannot affect the 
wage fund. This is commonly called the "residual 
claimant" theory of wages. It assumes that rent is 
determined according to the Ricardian doctrine ; that 
interest depends upon the law of supply and demand, 
which must give for the services of capital a re- 
muneration "high enough to induce tho.se who have 
produced wealth to save it and store it up, in the 
place of consuming it immediately for the gratifica- 
tion of personal appetite or tastes ;" and that profits 
are determined in the same manner as rent.^ From 
these, the conclusion is drawn that rent, interest and 
profits are normally determined by conditions en- 
tirely independent of those that determine wages, 
so that the.se .shares cannot, under the conditions 
assumed as normal, interfere with the laborer's 
share. And it is affirmed that in "so far as, by their 
energy in work, their economy in the use of ma- 
terials, or their care in dealing with the finished 
product, the value of that product is increased, that 
increase goes to them (the laborers) by purely 
natural laws, provided only competition be full and 
free. Every invention in mechanics, every di.s- 
covery in the chemical art, no matter by whom 
made, inures directly and immediately to their bene- 

• Walker, Political /Lco7iofny, p. 249. 



278 THEORY OF ECONOMICS 

fit, except so far as limited monopol}^ may be cre- 
ated by law for the encouragement of invention and 
discovery." 

' 'Unless by their own neglect of their own interests, 
or through inequitable laws, or social customs having 
the force of law, no other part}' can enter to make 
any claim on the product of industry,^ nor can any 
one of the three parties already indicated (the 
recipients of rent, interest, and profits) carry away 
anything in excess of its normal share. ' ' - 

125. This theory cannot stand the test either of 
experience or of a scientific anal3'sis of the economic 
process. Even according to the assumption as to 
the principles determining the other shares, upon 
which the theory rests, wages are not independent 
of those shares. One will not undertake the risk 
of cultivating land when he can secure more as a 
laborer.^ Hence, when wages are low a less pro- 
ductive land will be cultivated than when wages are 
high. Instead then of rent, even according to the 
Ricardian doctrine, being independent of wages, 
an assumed wage-rate is essential to determine the 
starting-point of rent. 

1 Exception is made of the state and the speculator. 

2 Walker, Political Economy, p. 251. 

^ The satisfaction derived from the comparative independ- 
ence that attends the cultivation of one's own farm and the 
influence of the hope of gain from the increase in value of 
one's property are, of course, part of the inducement to own 
and cultivate land, which must be considered to offset some 
of the return that could be secured from employment as a 
laborer. 



WAGES 279 

Again, the rate of interest is conceived to be 
such as will induce men to save for the building of 
a fund of capital, and it is determined by the rela- 
tion of the supply of capital to the demand there- 
for. But the character of the inducement to save 
and, therefore, the amount that will be saved, i. e., 
the suppl}^ of capital, depend in part upon the op- 
portunity for profitable investment. This is in- 
fluenced by the possible profits and these, in turn, 
by the expenses of production, including wages. 

So, also, the no-profit class, as conceived by this 
theory, depends, at an}^ given time, upon the stand- 
ard of wages, for men will work for wages instead 
of assuming the responsibility of an emploj^er, un- 
less the prospective reward as an employer is larger 
than the prospective reward as a laborer. So the 
standard of wages is an element in determining 
profits, even according to the rent theory of profits. 
Indeed, upon this point, the relation of wages to 
profits is not a matter of inference, but is explicitly 
set forth in the exposition of the theory. It is ex- 
pressly^ stated that the "no-profits" employer is one 
whose return is so small as to be "practically equal 
to what he would receive if employed by others." 
As a matter of fact, no share is determined inde- 
pendently of the others, for each influences the 
supply of and the demand for the services of the 
several factors, and affects, therefore, the returns 
for those services. 

Fundamental also to the theory that under 
normal conditions the laborer receives the increase in 



280 THEORY OF ECONOMICS 

product which results from his increased efficiency, 
is the assumption that "competionis full and free." 
When this assumption is analyzed it will be found 
to involve all that the theory seeks to prove. 
The condition of competition upon which this 
theory of wages rests assumes (1) that competition 
among employers is free to the extent that if one 
employer will not pay the laborer the increase in 
product which follows his participation in the busi- 
ness, another employer is at hand who will do so, 
and (2) that competition among laborers is such 
that if one laborer is not willing to work for the 
amount of product which follows his participation 
in industry, another one can be found, who will. 
In other words, the laborer receives the increase in 
product which follows his participation in a pro- 
ductive operation because, by hypothesis, conditions 
are such that he can obtain it; he receives no more 
than this amount, because, by hypothesis, conditions 
exist which prevent him from doing so. 

Moreover, under the conditions a.ssumed, that 
which professes to be "full and free" competition, 
is in fact not such. The amount received by the 
laborers equals what is added to product by their 
participation in the industry, only because the 
laborers are not free to compete beyond the point 
where they receive this amount, and because the 
employers also are not free to compete beyond that 
point. In other words, the theory prescribes very 
definite limits within which competition is free. 
Beyond these limits, it ceases to be free. 



WAGES 281 

It is significant that in the theory as presented, 
no attempt is made to show how such a state of 
competiton as is assumed, can be realized. Were 
the analysis carried further, it would be found that 
the condition of competition assumed, is possible 
of realization only when the influence of monopo- 
lization suffices to withstand the further operation 
of competition, both among laborers and employers, 
at the point where the laborers receive the portion 
of product which results from their participation in 
the industry. Except for the counteracting in- 
fluence of monopolization by the laborers, they could 
not withstand a decrease in wages below the amount 
mentioned; and, on the other hand, but for the in- 
fluence of monopolization, working in the interest 
of the employers, the laborers could and would use 
the same power of control which enabled them to 
bring wages up to this point, to force them still 
higher. 

126. Though at any given time, there is a certain 
amount of product which actually goes to constitute 
wages, it is not to be inferred that this is a prede- 
termined amount, so fixed and destined to pay 
labor that the share of the individual laborer is 
bound to decrease as the number of laborers in- 
creases, or to increase as the number of laborers 
decreases, with the result that an increase in the 
share of any one laborer involves a decrease in the 
share of some other laborer, and vice versa. This 
view, which is essentially that of the so-called 
"wage fund theory," has had wide acceptance. 



282 THEORY OF ECONOMICS 

It finds some apparent support from the fact that 
the amount of wages is influenced by total product 
and that the rate of wages is usually determined in 
advance of production, and, indeed, that wages are 
often paid before the product is disposed of. 

The theory involves the mistaken idea that, of 
the existing product, the amount which can consti- 
tute wages is fixed, and that wages are independent 
of future product. Whereas, of the existing fund 
of wealth, the amount that may constitute wages 
is variable. If the existing product more than 
sufiices to meet the minimum limits of the several 
shares, it is possible that some of the excess will 
be paid to the laborers. Furthermore, in so 
far as the exigencies of the laborers do not 
necessitate the immediate use of their share, 
the amount to be paid to them may wait for future 
product and be influenced thereby. The prospect 
of large returns to an industry may and often does 
result in an increase of wages. 

On the other hand, since the demand for 
labor is influenced by prospective production, 
while wages are u.sually paid after work is done, 
and even where an employer advances wages, he 
expects to reimburse himself out of product for 
such advances, it is sometimes held that wages de- 
pend entirely upon and are paid entirely out of fu- 
ture product. 

Ultimately, it is true, the amount of product must 
at least replace that which is expended in produc- 
tion, or economic progress will cease, but it does 



WAGES 283 

not follow that wages are paid entirely out of or 
depend entirel)^ upon future product. To the 
extent that the laborer, during the process 
of production, consumes existing wealth, he re- 
. ceives his wages from existing product, and but 
for that product and the wages so paid, there would 
be no future product. To the extent, also, that the 
existing supply of commodities determines the 
prices of those which the laborer purchases, the 
amount of real wages depends upon existing prod- 
uct. In general, it may be said that the relation of 
past and future product to wages depends wholly 
upon the extent to which they influence the sup- 
ply of and the demand for the services of labor. 

127. With respect to the relation between the 
variations in the wages of different laborers, it is 
alike erroneous to say, on the one hand, that an in- 
crease or decrease in the wages of one necessarily 
involves an opposite movement in the wages of an- 
other ; or, on the other hand, that a movement in 
the wages of one cannot affect the wages of another. 
Owners of the different factors compete with each 
other for a share of total product; and within each 
class, the members thereof compete with each other 
for a portion of the share which goes to that class. 
The former affects the total amounts which go as 
rent, interest, profits and wages ; the latter affects 
the amount which accrues to each individual in a 
class. The total wage fund depends upon the 
amount of total product that labor can secure. An 
increase in the total wage fund which results in in- 



284 THEORY OF ECONOMICS 

creased efficiency of labor, may so increase product 
as not to decrease any share. But where an increase 
in the wage fund is due to increased monopoliza- 
tion by laborers, without an accompanying increase 
in product, there follows a decrease in one or more 
of the other funds. 

Again, where an increase in the wages of some 
laborers occurs as a result of an increase in the 
wage fund, no other laborer suffers a decrease. 
But should the wages of any increase without a 
corresponding increase in the wage fund, the gain 
to those receiving this benefit would be at the ex- 
pense of fellow laborers. Any one of these alterna- 
tives is a possibility in the distribution of product. 

128. As has been seen, the use of a standard unit 
with which to measure values in the process of ex- 
change, introduces complications into the determin- 
ation of the several shares, because of its possible 
effect upon prices. Variations in the value of that 
standard result in variations in prices, and where 
the prices of some commodities respond more readily 
to changes in the value of that standard than do 
others, the relative status of the members of so- 
ciety is disturbed. In this connection it is neccessary 
to recall the distinction made^ between the nominal 
shares and the real shares. Nominal wages are the 
amount received by the laborer in the medium of 
exchange; while real wages depend upon the nomi- 
nal return to the laborer and the purchasing power 
of that return. Thus, if one of two masons receives 

1 See l 101. 



WAGES 585 

$5.00 a day and the other $2.50 a day, the nomiual 
wages of the former are twice as high as those of the 
latter, but if the former is obliged to pay twice as 
much as the latter for the same grade of commodi- 
ties, the real wages of the two are equal. So far as 
labor is concerned, an increase in the prices of gen- 
eral commodities is a decrease in real wages, unless 
accompanied by a corresponding increase in nominal 
wages; and a decrease in the prices of general com- 
modities, unaccompanied by a corresponding move- 
ment in nominal wages, is an increase in real wages. 
To the extent that wages are matters of contract 
or custom they change more slowly than do the 
prices of general commodities, hence an increase in 
the prices of general commodities involves at least a 
temporary loss to the wage earner, and a decrease 
in the prices of commodities, a temporary gain. 
These results tend to be offset in a measure, by an 
increased demand for labor when prices of general 
commodities rise, and a decreased demand for 
labor when prices fall. But in the absence of 
combinations for mutual assistance, laborers are 
specially susceptible to the influence of com- 
petition, a fact that renders labor more liable 
to loss from an increase in the prices of gen- 
eral commodities than to gain from a decrease in 
such prices. However, the extensive organization 
of labor in modern industry materially lessens this 
tendency of the laborer to lose as a result of varia- 
tions in the prices of general commodities, for it in- 
sures a more prompt increase in nominal wages 
when prices of general commodities rise. 



NDEX. 



(References to pages.) 



Activity, economic, 4, 54, 56. 

See also Incentive to activity. 
Administration, 14. 
Advertising, 156. 
Alternatives in exchange, 192, 

195. 

Basis of distribution, 172. 

Capital, 91, 93, 242, 243, 246, 

248. 
Character, 100. 
Circulating capital, 93. 
Commercial interest, 244 ; rent, 

228 ; wages, 272. 
Competition, 9, 58, 60, 61, 65, 

194, 196, 201, 202, 214, 217, 

219, 230, 274, 280. 
Contract, right to, 136. 
Contribution to production as a 

basis of distribution, 181. 
Copyright, 133. 
Corporate organization, 141. 
Cost of production, 37, 196. 
Credit, 138, 190. 

Demand, 38, 40, 76, 144. 

Development of demand, 76, 
144. 

Development of wants, 146. 

Diminishing returns, law of, 77, 
79, 80. 

Distribution, 165. See also 
Basis of distribution, Ex- 
change, Interest, Profits, 
Rent, Shares, Wages. 

Division of function, 105, 113. 
See also Economic organiza- 
tion. 



Economic activity, 4, 54, 56. 

Economic organization, 82, 105, 
165. 

Economic process, 53. 

Economic progress, 64. 

Economics, 3. 

Economic want, 19. 

Effort, relation of, to develop- 
ment of wants, 146. 

Enterprise, 98, 99, 257, 260, 272. 

Equality as a basis of distribu- 
tion, 175. 

Ethics, 11, 14. 

Exchange, 185, 213. 

Expansibility of wants, 151. 

Factors of production, 81, 86. 
Faith, relation of, to activity, 

127. 
Finance, 14. 
Fixed capital, 93. 
Free competition, 61. 
Fundamental concepts, 18. 
Fund to be distributed, 210. 

General wants, 19, 28. 

Habit, 150. 

Healthfulness of wants, 154. 

Heredity, 95. 

History, 14. 

Incentive to activity, 82, 125. 

Increasing returns, law of, 78, 

80. 
Interest, 242, 279. See also 

Shares in distribution. 



Jurisprudence, 14. 



287 



288 



INDEX 



Labor, 86, 94, 95, 271, 274, 27(1 

Land, 87, 131. 

Law of diminishing returns, 77, 

79, 80. 
Law of increasing returns, 78, 

80. 
Law of price, 201. 
Law of value, 86, 42. 
Limited liability, 140, 141, 142. 
Limits to property rights, 133. 
Limits to the right to contract, 

139. 

Malthus on population, 145. 

Material, 89. See also Capital. 

Maximum limit to price varia- 
tions, 200, 201. 

Maximum limits to shares in 
distribution, 216, 223, 225, 
243, 260, 258, 272. 

Measuring, process of, 30. 

Measuring value, 32. 

Medium of exchange, 188, 206, 
22p, 284. See also Money. 

Minimum limit to price varia- 
tions, 196, 201. 

Minimum limits to shares in 
distribution, 216, 223, 224, 231, 
243, 249, 258, 261, 271, 275. 

Mobility of capital, 246, 248. 

Money, 24, 245, 251. See also 
Medium of exchange. 

Monopolization, 60, 62, 66, 80, 
198, 200, 202, 203, 214, 217, 
219, 229, 260, 281. 

Moral character, 100. 

Need of a basis of distribution, 
176. 

No-rent situation, 231. 

Normal economic activity, 56. 

Normal limits to price varia- 
tions, 196, 200, 201. 

Normal limits to shares in dis- 
tribution, 216. 

Nourishment, 96. 



Old Age Pensions, 142. 
Organization, economic, 82. 
Overproduction, 122. 

Patent rights, 132. 

Persistence of wants, 149. 

Physical wants, 152, 155. 

Politics, 14. 

Population, 79, 83, 144, 145. 

Power-in-exchange, 26. 

Power of want-attraction, 20, 
21, 23, 26, 32, 36. See also 
Value. 

Price, 29, 44, 191-208, 288, 266, 
284. 

Principles of distribution, 222, 
224, 242, 257, 271. 

Production, 78. See also De- 
velopment of demand, Econ- 
omic organization. Factors of 
production, Incentive to ac- 
tivity. 

Profits, 257, 279. See also Shares 
in distribution. 

Property rights, 129-136. 

Purpose of economic science, 5. 

Relation of economics to other 

subjects, 14. 
Religious faith, 127. 
Rent, 224, 278. See also Shares 

in distribution. 
Rent theory of profits, 262, 264. 
Residual claimant theory of 

wages, 276, 278. 
Ricardian doctrine of rent, 232, 

235. 
Rights, 127. 

Scientific character of econom- 
ics, 16. 

Scope of economics, 4, 12. 

Shares in distribution, 192, 204, 
209. See also Interest, Profits, 
Rent, Wages. 

Situation, 86, 87, 225. 

Slavery, 129. 



INDEX 



289 



Socialism, 136. 

Social sciences, 18. 

Sociology, 14. 

Specialization of wants, 156, 

159, 162. 
Specific wants, 19, 22, 28. 
Speculation, 123. 
Spiritual wants, 152, 155. 
Standard of living, 145. 
Standard measure (or unit) of 

value, 48, 220, 284. 
Statistics, 15. 
Steps in the economic process, 

68. 
Supply, 38, 47, 81. 

Trade, 206. 
Training, 97. 



Unearned increment, 241. 

Unification of design, 111, 113. 
See also Economic organiza- 
tion. 

Value, 26, 29, 32, 36. 

Value of services as a basis of 
distribution, 184, 212. See 
also Exchange, Shares in dis- 
tribution. 

Wage fund, 281. 

Wages, 236, 267, 271. See also 

Shares in distribution. 
Want, 4, 19, 28, 83, 85. See 

also Development of demand. 
Want - attracting power. See 

Power of want-attraction. 
Wealth, 20, 21, 23, 24, 73. 
Will, 100. 



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